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The IMF: the Wrong Business Model - or the Wrong Business? Jubilee Research@nef, 13 January 2006 Argentina and Brazil have announced their intention to repay their loans to the IMF early. After all the concerns about the Fund's over-exposure to these countries, with their recurrent debt and financial crises over the last 25 years, one might think this was good news. In fact, it could plunge the Fund into crisis. Together with Turkey and Indonesia, Argentina and Brazil are among the four largest borrowers from the Fund, together accounting for 70% of its outstanding loans. And another of these countries, Indonesia, declared in 2003 that it would seek no new finance from the IMF, but would run down its debt according to the original repayment schedule. In fact, between April 2004 and November 2005, almost every borrowing country reduced its debt to the Fund, cutting the amount outstanding from $90 billion to $66 billion. Even as this article was being written, another country - Bulgaria - announced that it was repaying its debts to the Fund early. Together with the decision to cancel some $3.3 billion of debts owed by the poorest countries, the latest developments mean the amount could now fall to about $40 billion by the end of 2006. The problem this poses for the IMF is that it relies on the interest on its lending to fund its own operational costs. And the less it is owed, the less interest it receives, so that it has less money to cover its running costs. Writing in the Financial Times on 5 January, Mohamed El-Erian concluded that the IMF might need a new business model. But the question is more fundamental than this. The real question is whether the Fund is, in fact, the wrong institution, doing the wrong job in the wrong way - whether an organisation which was established more than 60 years ago, through its failure to adapt adequately or appropriately to the radical changes in the nature of the global economy since, has outlived its usefulness in its present form. The root of the problem lies in the growing polarisation between "emerging market" economies, which no longer need to borrow from the Fund; and the bulk of low-income countries, whose economies have been so wrecked - largely as a result of the policies imposed on them by the IMF itself - that they can no longer afford to borrow the Fund's resources. The world, in other words, is becoming increasingly divided between "don't need" countries and "can't pay" countries, with ever fewer countries in between to pay the generous salaries of the IMF's staff and management. The IMF was originally designed, in the 1940s, to support developed countries facing temporary balance of payment problems within a fixed exchange rate system (for example, the UK in the 1970s). However, it has become increasingly irrelevant to the developed countries with the advent of floating exchange rates, increasing volumes of commercial financial flows, and the vast increase in the speed of international transactions made possible by computerisation. As a result, no developed country has borrowed from the Fund for a quarter of a century. (The last IMF programme for a developed country was for Portugal in 1983-84.) Even in the UK's financial crisis of 1992, which saw the pound fall out of European Exchange Rate Mechanisms (ERM), there was no talk of bringing in the IMF. Assisted by the oil price crises of the 1970s, and the debt crisis which hit most of the developing world in the 1980s, the IMF responded by trying to reinvent itself and to develop a much greater role in finance for developing countries, previously the territory of the World Bank. However, the latest developments are a sign that the middle-income countries are now making a similar transition out of dependence on the Fund. These countries played a critical role in allowing the Fund to keep going after it became superfluous to the developed countries' financial needs, with major lending in response, first, to the 1980s debt crisis, and then to the wave of financial crises in the 1990s. The Fund largely has itself to blame. Its role in the financial "rescues" in response to the wave of financial crises following Thailand's crisis in 1997 gave the Fund the opportunity to find a new role, and a new lease of life. But in practice, it simply demonstrated the Fund's total inability to adapt to the fundamental changes in the international financial system in which it had been instrumental, and its inappropriateness, as it currently operates, to deal with the resulting problems. Even before the dust had settled following the 1990s financial crises, the Fund was roundly and widely criticised for the inappropriateness of the policies it had imposed on the affected countries. Simply put, it had responded to a new and radically different kind of crisis, led by a rapid reversal of speculative capital flows, with exactly the same policy prescriptions that it used for the earlier generations of crises, which were led by over-indebtedness of governments. The result, unsurprisingly, was to make things worse, not better. The country which fared best in the crisis was Malaysia, which did not seek IMF support, but rather imposed capital controls, which the Fund was doing its best to eliminate. China, which did not liberalise its capital account at all, conspicuously succeeded in avoiding the crisis altogether. Still more importantly, the crises of the late 1990s demonstrated that the whole way the Fund operated was at fault, not merely the policies it sought to impose at the country level. The Fund was designed for the "old" style of crises, where time could be bought by governments suspending their debt-service payments, and the need for adjustment could be spread over time through rescheduling, or limited by debt cancellation. This meant that time could be taken to design a policy package, negotiate with the government, and put together a financing package, and that policy conditions could be imposed on future disbursements. But an IMF programme takes time to set up, while negotiations are conducted on the policy conditions to be attached, and on a financial "rescue" package. This was manageable in "old"-style debt crises, because governments could suspend debt-servicing payments pending the completion of negotiations. In "new"-style crises, however, the nature, and the sheer scale, of "hot money" means that governments can face massive outflows within a matter of days the moment the crisis strikes - and that governments have no effective means to control the haemorrhage without capital controls. This means that large amounts of new financing need to be made available immediately; but the much greater size of the package required also makes the negotiations much more complex and therefore slower. So by the time the money arrives, the country has already suffered serious economic damage, and incurred major social costs. The problem is compounded by the insistence on phasing support over time, so that future payments can be subjected to conditions on economic policy and performance. This both reduces the amount available up-front, when it is most needed, and reduces the certainty of future disbursements being available, seriously limiting the effectiveness of the response in the crucial role of calming nervous or predatory markets. In short, the Fund used its "old" methods to deal with the "new" crises - and the result was little short of disastrous for the countries concerned. And it shows little sign of learning the lessons, and finding a more appropriate and effective way to deal with future financial crises. Rather, they appear to have sunk back into complacency, relying on greater transparency to stop future crises occurring. For all the talk of changing the global financial architecture in the late 1990s, all that has happened has been a token effort at cleaning the windows. Now, for once, it is the Fund's turn to suffer the consequences of its own ineptitude. Following the spectacular failure of the late 1990s, the "emerging market" countries have understandably made a determined effort to ensure that they never have to go cap-in-hand to the IMF again, by building up large foreign exchange reserves which they can use in response to any future financial problems. This process has its own costs, in that it means lending money to developed country governments at a relatively low rate of return, by holding larger reserves in low-yielding Treasury bonds and the like, rather than spending the money on development, which would bring much higher social rates of return. This is the price they are paying for the Fund's failure (and, ironically, are paying to the developed country governments, who effectively run the Fund). But it leaves countries freer to follow their own path with regard to government policy, and should allow them to avoid relying on the fundamentally flawed international system to resolve future financial problems. While the "emerging markets" are progressively ensuring that they no longer need the Fund's "help", the financial situation of most low-income countries is becoming increasingly precarious. Their financial needs could hardly be greater. But their problems are not of liquidity, but of solvency. In other words, it is not new borrowing they need, because they could not afford to service it, but rather the cancellation of the debts they already have - including those they owe to the Fund. Again, the Fund's problems are largely self-inflicted. It has played a central role in the response to the debt crisis - and an equally central role in the failure to deal with it effectively for the last quarter century. While the Fund's modus operandi is, in some respects, better suited to dealing with debt crises than financial crises, in practice, it has once again failed quite spectacularly to do so. This is again partly a result of pushing policy prescriptions which have proved singularly ineffective in achieving their objective (resolving debt problems), while imposing unnecessary and excessive costs in terms of economic and human development and wellbeing. But it is also partly a result of the Fund's (and developed country governments') persistent state of denial about the nature and extent of the debt crisis; their failure to respond to it appropriately or effectively by providing adequate debt relief where and when it is needed; and their cynical abuse of the dependency of developing country governments as a result of the crisis to impose economic policies which promote their commercial and ideological agendas at the expense of the people of the countries concerned. Moreover, the crisis itself was generated to a great extent by their irresponsible lending to illegitimate regimes, even when they knew the funds were being misappropriated (as in Zaire during the Mobutu era); and the Fund's failure to manage the economic consequences of the oil price shocks of the 1970s in the interests of the developing countries, which make up most of the world's population. By failing to provide the level of debt cancellation required, and always delivering too little too late, the creditors have caused serious damage to low-income debtors' economies. The result has been that debt cancellation has never caught up with the ever-declining capacity of countries to service their debts, locking them into a downward spiral of decline. Now, even after partial debt cancellation, most of the countries the Fund has "helped" cannot even service their remaining debts without depriving their populations of basic education and healthcare, and some are verging on economic and social collapse. The failure to deal with the debt crisis effectively, in turn, is largely a result of the Fund's appallingly anachronistic governance structure, unchanged since the colonial era. The developed countries, which have just 14% of the world's population and are not directly affected by the Fund's programmes, have more than 60% of the votes; and Western European governments collectively appoint the Managing Director. This allows the developed country governments to use the Fund as an instrument of economic control over developing countries. Neither is there any sign that they are prepared to relinquish this neo-colonial power. The IMF's current dilemma is thus almost entirely of its own making. Its policy prescriptions are wrong, and now largely discredited; its financing mechanisms cannot do the job they are supposed to do in the contemporary world; and its governance structure prevents it from reforming itself to remain relevant - or possibly even viable. In consequence, its long-disenfranchised "clients" are deserting it if they can; and those which cannot are unable to keep the Fund in the style to which it has become accustomed. This is not just a question of whether the Fund is using the wrong business model. It is a question of whether the Fund is the wrong institution trying to do the wrong job in the wrong way. The question now is whether it is enough for the Fund to swallow its own medicine, and undertake its own structural adjustment programme - to cut its own spending in line with its declining income, regardless of the consequences for its own staff and management. Or is it time for the world community at last to recognise that an institution designed in the 1940s, which has proved incapable of adapting to the realities even of the last quarter of the 20th century, let alone to the 21st, needs to be replaced with something more in keeping with contemporary needs and values. Either way, there must be some worried faces on 19th Street. And perhaps, here and there, the flicker of an ironic smile in the South. |
