The IMF and the Future

Graham Bird

• Publisher: Taylor & Francis
• Year: 2014
• Print ISBN: 9780415299879
• eBook ISBN: 9781134700776
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

The International Monetary Fund has been criticised from both the right and the left of the political spectrum with the right arguing that it is too interventionist and creates more problems than it solves and the left on occasion demanding that it be abolished altogether. What seems almost beyond question is that the IMF needs to be reformed.
Defining a future role for the IMF will always be a controversial issue, but vital to any considerations will be a measured assessment of how it has operated in the past. This excellent new book from an internationally respected expert on the IMF intends to do just that. Starting with an historical background tracing the evolution of the IMF, the book goes on to cover such themes as:
*The circumstances under which countries turn to the IMF
*The various aspects of IMF conditionality
*Institutional issues such as lending facilities and how the fund is resourced.
Bringing together an array of articles, this excellent new book will undoubtedly be required reading for anyone with a serious interest in development studies as well as being an eye-opening read for policy makers involved with the IMF.

1 A suitable case for treatment?

Understanding the ongoing debate about the IMF

Although the International Monetary Fund (IMF) has been a much-studied institution since its inception at the Bretton Woods conference in 1944, it is probably fair to say that it has never received such close examination and critical analysis as it has since the mid-1990s. This rush of interest started somewhat artificially with the 50th anniversary of Bretton Woods and the deliberations of the Bretton Woods Commission, but became more compelling as the wider debate about a new international financial architecture gained momentum in response to various economic and financial crises. Accusations that the Fund mishandled the crises in East Asia in 1997, and in Russia in 1998, combined with broader criticism of its systemic role in a world economy dominated by large and volatile private capital flows gave the debate a sharper and more immediate focus.

Even large industrial economies now feared that they might not be exempt from the spillover effects of crises in emerging market economies and, in some quarters, the crises were seen as the 'Achilles heel' of global capitalism. In this context, attention has been paid to the part that the IMF might play in helping to avert such crises or to minimize their adverse global effects, should they occur.

Moreover, the large loans that were associated with its involvement in crisis countries meant that the Fund itself became short of liquidity. The decision as to whether or not to increase its capital base provided both a further opportunity, as well as the motivation, to reassess its role. Clearly the world economy at the end of the twentieth century was very different from the one that had existed in the middle of the century, when the Bretton Woods institutions were set up; it was natural therefore to consider whether these institutions had adapted appropriately to meet the contemporary challenges the world economy now appeared to face. Ultimately, did the world still need the IMF? If so, did it need it in its current or some modified form?

Against this background there has been a spate of reports published seeking to assess the pros and cons of the Fund's operations and to plot out the direction that the reform should take. Indeed, when combined with the academic and popular literature on the subject there has been a veritable avalanche of material produced about the Fund. It is easy to get swept away in this, but in so doing to fail to isolate the principal issues that lie at the heart of this debate and also to fail to distinguish areas where there is consensus from those where there is dissent. The purpose of this chapter is to provide a guide to help understand the ongoing debate about the future of the IMF. It aims to provide a brief historical background to explain how the Fund's activities have evolved over time, and to isolate the central questions to which this story of evolution gives rise, putting the current debate in context. The next section identifies the principal historical landmarks and traces out the evolution of the debate about the Fund. The following section summarizes the Fund's contemporary sphere of operations. The next section extracts the key issues that emerge from the foregoing discussion and that dominate the current debate. The final section offers a few concluding remarks about the political economy of reforming the IMF.

A brief historical background¹

The Bretton Woods conference in 1944 represented a response to the international financial 'anarchy' that had existed in the 1930s as countries pursued beggar-my-neighbour policies in the form of competitive devaluations and protectionist commercial policy. Against a backdrop of global recession and shrinking world trade there was a belief that an international monetary order could be established that would facilitate global expansion and 'full' employment without having to revert to the rigidities imposed by the gold standard.

Of the two principal plans discussed at Bretton Woods, the US plan presented by Harry Dexter White was generally favoured over the more ambitious Keynes Plan put forward by the United Kingdom, which involved a new international currency, bancor, and an International Clearing Union in which countries would hold bancor accounts which would then be used to settle international debts. The White Plan maintained that all that was needed was some form of relatively modest stabilization fund that would provide countries with short-to-medium term financial assistance to tide them over during periods of balance of payments deficit while they corrected their underlying domestic macroeconomic disequilibria. Although some acknowledgement was made of Keynes' concerns about the potentially asymmetrical distribution of the adjustment burden between deficit and surplus countries by including a 'scarce currency clause', which in principle enabled pressure to be exerted on countries which persistently ran surpluses, the Articles of Agreement emerging from Bretton Woods essentially created White's stabilization fund.

Borrowing from the IMF did not initially involve 'conditionally' - this was introduced in the 1950s as the United States continued to fear that it might in effect be required to underwrite the Fund's lending operations. By the time the Bretton Woods system was up and running at the end of the 1950s, when the free convertibility of European currencies was introduced, the IMF had assumed the general role of overseeing, or even managing, the Bretton Woods system.

This system involved countries pegging the par values of their currencies, and only altering them in the event of a 'fundamental disequilibrium', where domestic and external policy targets became incompatible at the pegged exchange rate. However, not all currencies were treated equally. The US dollar was made the pivot of the system, with its price being tied to gold. Although in principle involving an adjustable peg system for exchange rates, the reality was that pegs were not adjusted very frequently so that balance of payments correction, in fact, relied heavily on managing domestic aggregate demand.

Within the context of the Bretton Woods system the IMF fulfilled four key functions. First, it was an adjustment institution offering advice and some degree of compulsion in terms of appropriate domestic macroeconomic policy. Second, it was a financing institution providing short-to-medium term financial assistance in support of approved policy, designed to eliminate balance of payments deficits. Third, it helped to co-ordinate macroeconomic policy internationally by encouraging countries to design policies in ways that supported pegged exchange rates, in effect supervising a rule-based system of macroeconomic co-ordination. Finally, it acted as a forum for the debate of international monetary reform.

Although never completely free from contemporary criticism, during the golden age of the 1950s and 1960s criticisms of the Fund were muted. The Fund had been set up to run a system designed to encourage global economic growth, full employment and expanding world trade and on all counts the world economy seemed to be performing quite satisfactorily.² During the 1960s debates involving the Fund focused instead on, first, its potential contribution to creating additional global liquidity and, second, whether it needed to modify its lending operations to accommodate what developing countries presented as their particular and unique problems.³

In terms of global liquidity the fear was that, within a system involving infrequent exchange rate changes and a relatively inefficient adjustment mechanism, inadequate liquidity would threaten future global economic growth, and that, with the rapidly growing Eurodollar market, a shortage of official reserves would expose the system to the threat of exchange rate crises associated with speculative attacks on currencies. This debate culminated at the end of the 1960s with the introduction of Special Drawing Rights (SDRs) - an international reserve asset that the IMF could itself create as it deemed necessary.⁴

In terms of the special interests of developing countries, the Fund relaxed its initial approach, which was that its standby agreements adequately met the needs of all its member countries, and during the 1960s introduced first the Compensatory Financing Facility and then the Buffer Stock Financing Facility, each of which was, in its own way, designed to deal with the problems of export instability and adverse terms of trade movements. Unlike standby arrangements, drawings under these facilities involved only modest or 'low' conditionality, reflecting the view that export instability was largely exogenous and required liquidity rather than adjustment.

However, these reforms failed to prevent the collapse of the Bretton Woods system during 1971—3. To what extent was the IMF to blame for the collapse? In a sense it cannot be exonerated from blame. After all, the Fund had been designed to operate the Bretton Woods system, and yet it clearly failed to prevent developments that led to the system's eventual breakdown.⁵ In essence, it had riot prevented currencies from becoming seriously misaligned. Whatever its share of responsibility, the legacy of the collapse of the Bretton Woods system was to call into question the future of the Fund. If it was there to supervise the Bretton Woods system, why was it needed once that system had collapsed? While this question was asked by several commentators, a more measured analysis of the need for international financial reform and of the IMF was preferred, at the time, by the so-called Committee of Twenty (C20). While still emphasizing the importance of stable exchange rates, the C20 recognized that greater exchange rate flexibility could be appropriate. It also envisaged a larger role for the SDR as a reserve asset and an extension of IMF lending into the medium to longer term in association with structural change.

As the debate about international financial reform was going on, the world was in effect forced by expediency to adopt generalized flexible exchange rates in 1973 to try and correct persistent currency misalignment, and encountered an enhanced need for international financial intermediation in the context of the quadrupling in the price of oil in 1974, which created large surpluses in the oil exporting countries and large deficits among oil importers.⁶ While the Fund responded by creating a temporary Oil Facility designed to recycle oil revenues from oil producers to countries with oil-related balance of payments deficits, the task of recycling petrodollars was largely performed by private international banks.

In broader terms, during the 1970s the IMF became marginalized as an institution. Its adjustment role was reduced by the introduction of exchange rate flexibility. Its lending role was overshadowed by international financial intermediation by the private banks. Its macroeconomic co-ordination role seemed less relevant where it was believed that flexible exchange rates would insulate countries from external shocks. Even its role as a forum for international monetary reform was reduced by the trend towards regionalization in Europe and the existence of other fora with overlapping spheres of responsibility.⁷ Moreover, with flexible exchange rates and large private capital flows, the issue of the global adequacy of official international reserves became, in many ways, irrelevant. Although the Fund continued to set itself an (over) ambitious systemic target in terms of establishing the SDR as the principal international reserve asset, the reality was that the system evolved more in the direction of multiple reserve currencies; even the Fund's own asset faded into obscurity.

There were also changes in the global economic paradigm that had a bearing on the Fund. The Bretton Woods system had been devised by reasonably likeminded Keynesians and the IMF was designed to provide countries with financial assistance in order to help them avoid deflationary policies that would have adverse implications for economic growth and employment. During the 1970s the Keynesian consensus evaporated and by the beginning of the 1980s political leaders in a number of the Fund's major shareholders, who were anxious to reduce the role of government nationally, were at least ambivalent about the role of an intergovernmental organization such as the IMF. If the Fund had been established at a time of Keynesian consensus it became marginalized over a period of time when Keynesianism was under attack.

Attempts continued to address the special interests of developing countries which, during the 1970s, became the Fund's only clients, with the opening of a new medium-term lending window - the Extended Fund Facility (EFF) - the establishment of a Trust Fund, financed by IMF gold sales, to help provide concessionary assistance to poor countries through interest rate subsidies, and the liberalization of conditionality. In practice, the EFF was initially relatively little used and seemed to be unpopular both among borrowing countries and the IMF Certainly it did not seem to meet the needs of the world's poorest countries. Even so, by the beginning of the 1980s the IMF was lending exclusively to low-income countries. The better-off developing countries seemed able to meet their need for external financing by borrowing from the private international banks. An apparently natural division of labour had emerged between the IMF and private capital markets as the Fund dealt with those countries bypassed by the private banks. Critical analysis of the IMF focused on its involvement in developing countries rather than its eroded systemic role and concentrated on the design and effectiveness of coriditionality.⁸ Here critics of the Fund argued that, in design, conditionality reflected monetarist modes of thought, focused excessively on the demand side of economies to the exclusion of the supply side, and was insufficiently flexible to respond to country-specific needs. Others complained that conditionality was based on old-fashioned macroeconomics, that it misinterpreted the appropriate role of the state in many developing countries by emphasizing its 'crowding out' effects rather than its 'crowding in' effects, and that it was subject to a fallacy of composition in as much as policies that might be effective when pursued in isolation by one country would be ineffective when pursued simultaneously by a group of countries. New structuralists argued that IMF conditionality based on exchange rate devaluation and monetary contraction was stagflationary. More generally, critics claimed that the empirical evidence suggested that conditionality had little if any significant impact on key macroeconomic variables. The debate over conditionality - for there were counterclaims to each of these accusations - became and remains an enduring feature of most discussions of the IMF.

However, the ...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of figures
• List of tables
• Preface
• Acknowledgements
• 1 A suitable case for treatment?: understanding the ongoing debate about the IMF
• 2 Borrowing from the IMF: the policy implications of recent empirical research
• 3 IMF lending: how is it affected by economic, political and institutional factors?
• 4 IMF programmes - do they work? Can they be made to work better?
• 5 The effectiveness of conditionality and the political economy of policy reform: is it simply a matter of political will?
• 6 IMF programmes: is there a conditionality Laffer curve?
• 7 The credibility and signalling effect of IMF programmes
• 8 The IMF's role in mobilizing international capital: is there a catalytic effect?
• 9 Restructuring the IMF's lending facilities
• 10 Resourcing the Fund: direct borrowing from private capital markets
• 11 Crisis averter, crisis lender, crisis manager: the IMF in search of a systemic role
• 12 The IMF and developing countries: a review of the evidence and policy options
• 13 Political economy influences within the life cycle of IMF programmes
• 14 The political economy of the SDR: the rise and fall of an international reserve asset
• Index