Boston, MA – The International Monetary Fund (IMF) started operations 65 years ago this month. The global financial crisis has triggered some constructive new thinking and policy at the IMF – though the institution has continued some of its more concerning policies as well.
The IMF is definitely changing, but the question is whether or not it can truly become the “New Deal in international economics” that US Treasury Secretary Henry Morgenthau and the institution’s founders envisioned. It is easy to forget that the institution was created as a global “new deal” institution, because it abandoned those roots after a few decades. We need to remind ourselves that the IMF was created by John Maynard Keynes himself and Harry Dexter White, a Keynesian economist working in Morgenthau’s US Treasury during the administration of President Franklin Roosevelt. Political economist Eric Helleiner writes:
Both Keynes and his American counterpart, Harry Dexter White, saw the goal of bringing international finance under greater public control as a central objective of their blueprints. As Morgenthau put it rather dramatically at the Bretton Woods conference, the goal was to ‘drive the usurious money lenders from the temple of international finance’.
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In this spirit, the IMF’s articles of agreement charged the institution with acting like a credit union to help nations solve their balance-of-payments problems and to provide “surveillance” to monitor the financial health of the global economy. The IMF articles also officially sanctioned capital controls – counter-cyclical regulations on speculative capital inflows and outflows to prevent and mitigate financial crises. For more than 30 years, the IMF presided over the “golden age of capitalism” – during which Western nations saw unprecedented economic stability, expansion, employment growth and rising standards of living.
All that changed beginning in the 1980s, when Keynesian economic thinking was replaced by the “Washington Consensus” at the IMF. As its membership expanded to include the bulk of the developing world, the IMF began to advise nations to deregulate their financial sectors in order to allow foreign capital to flow freely in and out of countries without any capital controls.
Indeed, in the 1990s the IMF even made a move to change the original articles of agreement to that end. What’s more, the IMF’s recipe for recovering from a crisis became “one-size-fits-all” austerity plans with severe conditionalities attached to them. Finally, the new members received very limited voting power in the institution and thus had very little say over the terms of IMF programmes.
The IMF attached conditionalities on its lending from the beginning. However, in the 1980s the IMF started to attach what were perceived to be draconian “micro” conditionalities onto equally troubling austerity programmes. Countries were forced to privatise firms, deregulate markets and slash social spending. The social and political strife that resulted from these programmes has been enormous, with South Koreans still referring to the IMF’s presence in their country following the 1997 East Asian financial crisis as “the IMF years”. In a comprehensive study of IMF programmes in developing countries, James Vreeland of Georgetown University found that by and large, IMF programmes have hurt economic growth and redistributed incomes upward to the richest segments of society.
Because of its mismanagement of economic crises in East Asia, Argentina and beyond, by the turn of the century the IMF was a humbled institution. Many nations vowed never to return to the IMF and began to “self-insure” by accumulating foreign exchange reserves to defend their currencies and countries in the event of another crisis. Nevertheless, the institution continued its surveillance operations to monitor the global economy.
Then, in 2008, with no warning from the IMF, the world economy suffered the most significant financial crisis since the Great Depression. The IMF’s own Independent Evaluation Office (IEO) concluded that “the IMF provided few clear warnings about the risks and vulnerabilities associated with the impending crisis before its outbreak. The banner message was one of continued optimism after more than a decade of benign economic conditions and low macroeconomic volatility”. Why did the IMF fail at one of its core tasks? According to the IEO report:
The IMF’s ability to correctly identify the mounting risks was hindered by a high degree of groupthink, intellectual capture, a general mindset that a major financial crisis in large advanced economies was unlikely, and inadequate analytical approaches.
Despite this record, the IMF was brought back to life in the wake of the crisis. The G-20 reinforced the IMF with a pledge of $500bn, and the institution embarked on rescue programmes with a number of nations including Iceland, Pakistan, Latvia and Ukraine. And, of course, the IMF now serves as part of the “troika” in partnership with the European Commission and European Central Bank in an attempt to stem the eurozone crisis.
The IMF has reflected on its past wrongs, and has promised to change its ways in the wake of the crisis. The fund has created new lending facilities such as the Flexible Credit Line and the Precautionary Credit Line, which offer lines of credit to nations in order to prevent a crisis – as opposed to its traditional “stand-by” agreements for countries in dire need. Importantly, these new facilities attach very little by way of conditionalities and countries are free to use the lines of credit for purposes they see as fit.
Furthermore, the advice that the IMF gives to countries has begun to return to a Keynesian-like set of policy recommendations to prevent and mitigate crises. After IMF research found that capital account liberalisation was not associated with economic growth and stability, and other research showing that capital controls can be effective tools for macro-economic management, the IMF has begun to advise countries to deploy capital controls in order to prevent asset bubbles and exchange rate appreciation.
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The IMF has also loosened its stance on inflation targeting – manipulating interest rates to keep inflation in check – advocating the raising of targets from 2 per cent to 4 per cent. Finally, a recent IMF study looked at the experience with austerity in industrialised countries from 1978 to 2009, and found that for every 1 per cent of GDP in budget cuts, GDP declined almost two-thirds of a percentage point and the unemployment rate increased by one-third of a percentage point.
All these developments show that the IMF is showing some real signs of moving in the right direction. But when it comes to the standby arrangements for the countries most in need, it still seems a lot like the old IMF. It has officially changed its stance on these programmes – saying that the conditionality programmes no longer adhere to the most vulnerable segments of society, and that wholesale micro conditionalities like privatisation are a thing of the past. But their actions often speak louder than their words.
The austerity-minded, conditionality-driven IMF has reared its head in agreements with states such as Latvia, Ukraine and Pakistan in the wake of the crisis. In these cases, the countries still had to drastically cut public spending, privatise or deregulate the energy sector and slash food programmes. A Unicef report found that austerity measures were severely jeopardising children and the most vulnerable across the developing world.
However, there are some signs of newfound IMF flexibility, even in these standby agreements. Previously, if a state did not meet certain conditionalities, they would not receive further payment. Many of these nations missed their targets but were still able to secure further tranches. And while these countries were required to have an inflation target, such targets ranged from 4-6 per cent rather than the traditional 2-3 per cent. In the case of Iceland, the IMF endorsed the use of capital controls on the outflows of capital.
The IMF is in a period of what economist Ilene Grabel refers to as “productive incoherence“. There is a lot of very productive debate and change within the organisation, but it is often inconsistent and contradictory. New thinking about inflation targeting and capital flows has indeed crept into stand-by arrangements, but not the new thinking and hard evidence on austerity.
That said, the changes in the wake of the financial crisis are not to be overlooked and deserve applause. Part of the reason the institution is changing is due to the rising economic power of its developing members, such as China, Brazil and India. Along with this newfound power will come more voting power at the Fund.
If strategic coalitions are built, they can coalesce to make the institution more development-friendly – and live up to the promise laid out by its founders.
Kevin Gallagher is associate professor of international relations at Boston University and senior researcher at the Global Development and Environment Institute. You can follow him on Facebook here.