Structurally Adjusting the IMF

♠ Posted by Emmanuel in , at 9/28/2007 02:59:00 PM
And now here's an old-school, straight-up IPE topic: the fate of the IMF. As you know, the IMF was originally intended to be a lender of last resort when countries ran into balance of payments crises. When a country no longer had the ability to pay for its exports since its foreign exchange holdings were depleted, it had to call on the IMF. The most visible, relatively recent calls for help were made when the Asian financial crisis plunged East Asian countries into financial turmoil as foreign investors pulled out their FDI and portfolio investments en masse while regional currencies devalued severely. Countries that turned to the IMF had to follow tough "structural adjustment" policies that, above all, emphasized fiscal austerity. As Joseph Stiglitz famously suggested in Globalization and Its Discontents, these policies brought about severe social hardships since the socioeconomic effects of such policies were not often thought through.

Hit the fast-forward button and we now find a vastly changed global political economy: developing countries have accumulated vast reserves as mercantilist policies have taken hold, especially among Asian countries. The thinking behind such unprecedented accumulation is simple: "We've seen the terrible effects of resorting to the IMF and its 'structural adjustment' policies, so we're going to accumulate plentiful reserves to ensure we don't have to turn to the IMF." Even if these reserves could have arguably been used for better things such as health care and education as developing countries may have drawn the wrong lessons from the crisis, reserve accumulation continues apace. The flip side of developing countries weaning themselves off IMF support has been that the IMF has had little business for its lender of last resort function. Without lending, of course, the IMF earns no interest income.

What we have, nowadays, is the intriguing situation where the IMF needs to "structurally adjust" itself by undertaking fiscal austerity measures. Like the countries it so famously told to do some belt tightening, the IMF now needs to do the same. Here is an Economist introduction to the current financial state of the IMF:

What is a firefighter to do when there aren't any fires? The IMF spent 1994-2002 dashing from one financial conflagration to the next. But the sirens have been silent for some time. As a result, the fund's budget is shrinking and the morale of its staff is sinking. Some of its best customers are now doing without it, leaving some of its biggest shareholders wondering what to do with it...

Apart from generating reams of analysis, the fund's job is to furnish foreign exchange to countries that have temporarily run short. It can call on about $220 billion of hard currency in the first instance. That sounds like plenty. But some of its former customers now have big, shiny fire-engines of their own. South Korea, for example, has $217 billion in its vaults. Between them, eight East Asian countries (Japan, Singapore, Indonesia, China, Malaysia, the Philippines, Thailand and South Korea) command reserves worth about ten times the IMF total. These countries have even begun to pool a small fraction of their combined hoard, under what is called the Chiang Mai Initiative.

Lately no one has been calling on the fund's own supply. Brazil and Argentina have both repaid their debts. Only Turkey and Indonesia still owe it money on any scale. Quiet times are lean times for the IMF. Like any bank, it covers its running costs (which will amount to over $900m in the year to April 2007) from the interest it earns on its loans. But this financing model “is no longer tenable”, Mr de Rato's report says. By its own projections, the IMF will live beyond its means by almost $300m in 2009-10. The belt-tightening this implies has not gone down well with staff, who show little taste for the austerity they are notorious for prescribing to others.
In short, the IMF has gone from anti-globalization arch-villain to semi-irrelevant international organization in the space of less than a decade. The question has become, "is the IMF still relevant in today's global political economy?" With the imminent appointment of Dominique Strauss-Kahn as IMF chief, this matter has come to the fore. Some suggestions include (a) enhancing the IMF's surveillance role over exchange rates (though this is a contentious matter; (b) broadening the participation of developing countries in global economic governance; and (c) doing medium- to long-term lending like the World Bank. It's interesting stuff, and the International Herald Tribune identifies some of the key emerging issues for the IMF.
A decade ago, the International Monetary Fund helped to stabilize the world economy after markets collapsed in Latin America, Russia and Asia. While conservatives denounced its role in bailing out investors, liberals assailed its austerity measures imposed on several troubled economies.

Today the only crisis faced by the IMF is a crisis of identity. Countries rescued in the 1990s have mostly repaid their debts.

On Friday Dominique Strauss-Kahn of France is to be named the new managing director of the IMF, succeeding Rodrigo de Rato of Spain, who is resigning. He arrives at a time when the Bush administration, which backed him for the job, has joined a global chorus calling on the fund to rethink its priorities and its governance.

With a shrunken loan portfolio, the institution that lectures others about finances has lost operating income, is running a deficit and is facing staff cuts and considering the sale of gold to meet expenses...

"What might be at stake today is the very existence of the IMF as the major institution providing financial stability to the world, a global public good," Strauss-Kahn, a former French finance minister, told the fund's directors last week. "In sum, the two main issues are relevance and legitimacy."

The other key issue to be considered is the way the world's wealthiest countries choose the person to run the fund. Since the fund was established after World War II as part of the Bretton Woods postwar economic architecture, its chief is chosen in private by the leading powers in Europe.

After President Nicolas Sarkozy of France nominated Strauss-Kahn this summer, his selection was a foregone conclusion, just as it was inevitable that President George W. Bush would get his way in picking Robert Zoellick this summer to head the World Bank after the ouster of Paul Wolfowitz, the former U.S. deputy defense secretary.

But there is widespread unhappiness and embarrassment among the fund's board members over the clubby nature of the process, especially among the countries in Asia and Latin America bailed out in the 1990s. Many are now export powerhouses sitting on huge reserves and no longer need or want the fund telling them what to do.

Russia hoped to capitalize on these feelings in challenging the selection of Strauss-Kahn. It nominated its own candidate, Josef Tosovsky, a former prime minister of the Czech Republic, who told the board that as a "representative of an emerging market transition economy," he would bring a different perspective to the job.

Aleksei Mozhin, the board director representing Russia at the fund, said his country was "very, very proud" to nominate Tosovsky. "It is an open secret that the fund is barely alive," he added. "It is in the business of survival. The traditional modus operandi of the fund - you need our money, we tell you what to do - is gone."

De Rato, the outgoing managing director and a former economy minister in Spain, has won widespread credit for initiating many of the changes and rethinking at the IMF, though the Bush administration has made no secret of its impatience over the pace of change.

Last year, with American backing, the fund agreed to give more voting shares to China, South Korea, Turkey and Mexico.

A plan to further expand the voting shares of these and other emerging economies is still being debated. The Bush administration fears that if such steps are not taken, these countries may break away from the fund.

The administration has also gotten the fund to do more to monitor currency manipulations by trading partner countries, especially China, which Treasury Secretary Henry Paulson Jr. has accused of buying dollars to keep the value of its currency low so that its exports can be sold more cheaply in the United States [this is the contentious part].

As a result of American and European pressure, a panel set up by De Rato called on China to end its currency interventions earlier this year. It also called on Europe to deregulate its economy and on the United States to do more to close its looming fiscal deficits in the coming decades.

Paulson has made little secret of his desire for the fund to be more aggressive in pressing China on this issue. Treasury officials were irritated earlier this year when De Rato said he could not lecture China any more than he could lecture Bush about the projected cost of Social Security and Medicare [good comeback, De Rato--the IMF should not be an extension of US policy].

"We're satisfied that there has been progress on the currency issue," said Clay Lowery, an assistant secretary of the Treasury for international affairs. "But more needs to be done for the IMF to be as relevant as it has been in the past."

In speeches, De Rato has said that, with its fading role in bailing out countries in crisis, the fund's new priorities should be in urging countries to take actions to prevent crises, monitoring the global economy and providing technical assistance. Fund officials say that Strauss-Kahn is likely to continue these policies.

But the French nominee has also told fund directors and some interviewers that he wants the organization to do more to alleviate poverty - a statement that some American officials say they hope does not lead to its trying to supplant the World Bank.

If the fund concentrates solely on monitoring the economy and seeking greater disclosure in the world financial system, that would suit some of its critics well. Adam Lerrick, an economist at Carnegie Mellon University in Pittsburgh and the American Enterprise Institute, a private research organization in Washington, is among those who say that the IMF needs to rethink its role in that direction.

"Without radical reform, the IMF will soon be totally irrelevant," Lerrick said. "The fund should focus on data gathering and the dissemination of financial information. Surprise causes financial crises. The more information markets have, the less likely there will be a crisis."

But many experts also warn against the complacency of the moment and say that the fund should be kept healthy in order to play a role in a future global crisis, even if rescue operations have to be carried out also by other players with large pools of reserves.

"It worries me a lot when people say the IMF can just go away," said Anne Krueger, a former first deputy managing director of the fund and now a professor of economics at Johns Hopkins University in Baltimore.

"You have to think of the fund as something of an insurance policy for the member countries," she added. "Times are good right now. But there are so many important economic issues that can't be done bilaterally any more. Big countries and small countries recognize that they need the fund."