The IMF & Good Governance

Key Points

  • The IMF was created to solve short-term, external imbalances in national economies but has moved far beyond its original mandate.
  • The IMF makes decisions with major implications for poor countries yet lacks the expertise to provide far-reaching policy prescriptions. Its structure also inadequately represents the poorest countries, which are its main clients.
  • While judging good governance—telling governments to make documents more accessible and to open up their decisionmaking processes—the IMF remains unaccountable and undemocratic.

Both the International Monetary Fund (IMF) and the World Bank were created in 1944. Originally the World Bank was charged with spearheading postwar reconstruction, and the IMF was created as the “guardian” of the global economy, promoting unimpeded trade and ensuring that countries’ exchange rates were staying within their set values. In the 1940s, the values of world currencies were pegged to gold, and this was known as the “gold standard.” The IMF also provided short-term financing to countries that had difficulties defending their currencies’ values and meeting trade obligations. But the IMF’s financing was intended to stabilize economies—not restructure them.

When the gold standard was suspended in 1971, the IMF lost its core mission. Since then, the institution has searched for a new mission and justification for its existence. As a result, the Fund has consistently involved itself in affairs far beyond its original mandate. This has been done with grave consequences: the IMF, staffed with macroeconomists, does not have the expertise to provide the kind of advice that it is dispensing today. Nor is the Fund (which had no independent evaluation unit until 2000 and has been criticized for excessive secrecy) accountable for the policy advice that it gives.

The oil price shocks in the 1970s provided the IMF with a major opportunity to extend its mandate. The Fund offered short-term loans to help some countries meet increased oil costs. It also encouraged international commercial banks to lend massive amounts of oil dollars to developing countries. This practice led to excessive and dubious credit, which then contributed to the debt crises of the 1980s.

The debt crises gave the IMF another role: lending to countries on the brink of default, making the IMF the lender of last resort and the global economic policeman, as it stepped in and set up a system of debt repayment to the Northern creditors. Since then, developing countries have needed the Fund’s “seal of approval”—IMF endorsement of an economy—to obtain new aid flows, further creating a dependency on the IMF by developing countries and granting the Fund vast influence over these countries.

Beginning in the 1980s the IMF again extended the scope of its programs by moving into the development field, establishing its Structural Adjustment Facility (SAF) and Enhanced Structural Adjustment Facility (ESAF). Both these facilities have recently been merged into the IMF’s new Poverty Reduction and Growth Facility (PRGF). Through the PRGF, the Fund extends medium-term loans and sets strict economic conditions for broad sectors of a country’s economy. These conditions—which can include relaxation of labor laws, foreign investment incentives in natural resource sectors, and privatization schemes—go far beyond the IMF’s original purview of addressing short-term external imbalances.

Recently, the IMF pursued an amendment to its Articles of Agreement that would give it jurisdiction over capital-account issues and potentially obligate IMF member countries to remove capital controls by which they protect themselves against volatile short-term capital. Another new endeavor is the IMF’s involvement in “good governance,” taking up issues such as corruption, budget transparency, tax policy reform, and corporate bankruptcy. Good governance is becoming an important criteria in determining multilateral and bilateral aid flows and in granting debt relief. As the institution that bestows the “seal of approval” and whose programs must be followed in order to obtain debt relief, the IMF has a strong hand in determining whether a country is meeting its standard of good governance.

Although the principle of good governance is broadly endorsed, bestowing the IMF with the power to determine good governance is problematic. It further legitimizes the Fund’s power grabs of the last several decades and entrenches its dubious role of giving advice where it is not an expert. Moreover, the IMF’s own decisionmaking structures violate basic principles of good governance, such as representation and participation. The entire African continent, for instance, is represented by two individuals on the IMF board of executive directors, while the U.S. controls over 17% of the votes at the Fund. Such an imbalance of political influence undermines the consistent application of good governance criteria. If the IMF is to advocate good governance principles to its member governments, it must apply the same principles of transparency and accountability to its own operations.

Problems with Current U.S. Policy

Key Problems

  • The U.S. has used the IMF, including the fund’s policy on good governance, as a way of furthering narrowly conceived U.S. foreign policy interests.
  • The politicization of IMF lending decisions is created by its flawed voting structure, which is based on each member’s contribution to the fund.
  • Good governance at the IMF is also thwarted by the fund’s flawed practices of audit and evaluation.

In August 1997, the IMF released guidelines regarding its role in governance issues. According to then-Managing Director Michel Camdessus, “a much broader range of institutional reforms is needed if countries are to establish and maintain private sector confidence,” and “every country that hopes to maintain market confidence must come to terms with the issues associated with good governance.” The IMF announced plans to evaluate countries’ governance practices and to condition its loans on good governance. The Fund then flexed this new muscle when it withheld, beginning in the late 1990s, loans to Kenya because of corruption concerns.

This new interest in good governance comes after decades of IMF funding for some of the world’s most corrupt governments. Despite years of protests by civil society and political opposition leaders in Kenya, the IMF only suspended funding to Kenya in late 1996 after the Moi government failed to adhere to the Fund’s governance agenda. Funding resumed briefly in early 2000 and then was again suspended. The Fund loaned billions to Russia in the 1990s despite rampant evidence of corruption, as Russia’s political and business elites reaped the spoils from IMF-mandated privatization schemes. The U.S. Treasury Department has strongly supported these IMF loans for its own political reasons.

The politicization of IMF lending decisions is created by its flawed voting structure, which is based on each member’s contribution to the Fund. As the largest financial contributor to the IMF, the U.S. has the largest share of votes—17%. Together, the G-7 nations control nearly half the votes and thereby wield a heavy hand in setting the IMF’s agenda. In addition, many of the IMF’s most important decisions, such as amendments to its Articles of Agreement or use of the Fund’s gold reserves, require an 85% majority, thereby giving the U.S. veto power over the most critical decisions.

The U.S. has used its influence within the IMF as a way of promoting U.S. foreign policy through a multilateral façade. The IMF’s expanding mandate—from macroeconomic stabilizer to development fund to good governance expert—has enabled the U.S. to exert its agenda as well. In a break from the past, the U.S. Treasury Department now acknowledges the IMF’s expanding mission and has called for a “refocusing” of the Fund’s role. New IMF management has echoed that sentiment. However, U.S. and IMF officials refuse to rule out any specific areas where IMF conditionality is inappropriate. Conditionality will only be “streamlined” when the World Bank has an adjustment program that incorporates the conditions that the IMF and the U.S. Treasury want to see implemented in a country, leading to no real reductions in conditions.

As an institution promoting good governance, the IMF itself is still too secretive. Many important staff assessments of member country economies are confidential. Though loan documents are now generally available, they are released after board approval, when the public cannot influence decisions. The IMF’s governing bodies are excessively secretive: the board of executive directors which is the day-to-day decisionmaking body of the IMF, rarely takes recorded votes. Instead it negotiates a consensus behind the scenes and does not release its minutes.

Good governance at the IMF is also thwarted by the Fund’s flawed practices of audit and evaluation. Until 2000, the IMF had no independent evaluation unit. A unit is now being established. In addition, there is no mechanism that holds the IMF directly accountable for the quality of its advice and programs. For example, if a loan program is ill-designed, citizen groups in the country have no mechanism to hold the IMF directly accountable for its mistakes. A credible accountability mechanism is central to any system of good governance.

Although the IMF has taken a very important step forward by agreeing to participate in national public forums with civil society, government officials, and other donors, the loan negotiation process is still too exclusive and secretive. According to Article V of its Articles of Agreement, the IMF negotiates directly only with the finance ministry and central bank of each member country. This article should be amended, and the IMF should work with a full range of government officials, including parliamentarians.

Toward a New Foreign Policy

Key Recommendations

  • The IMF should return to its original mandate of monitoring economies and lending for short-term stabilization; loan conditionality should be curtailed.
  • The U.S. must play a leadership role in reforming the IMF, such as making the fund’s executive board more transparent and enhancing accountability through an independent evaluation unit.
  • The U.S. must give up its veto power at the IMF and work to increase the voting power and representation of poorer countries.

For a number of reasons, the IMF is facing an identity crisis. This identity dilemma has been fomented by the continued economic stagnation of the poorest countries, despite many years of structural adjustment. In addition, private financial flows have become increasing more important than public lending by the IMF, World Bank or other public institutions. And finally, the growing global justice movement of citizens around the globe raises questions about the role the IMF and other financial institutions. Given these criticisms, the Bush Administration should undertake a critical examination the Fund and of the U.S. role within this institution.

Any reform of the IMF must include downsizing its role and laying out guidelines for how it should carry out a more restricted mission. The IMF was created to monitor economic developments in the global economy and to address short-term external imbalance when necessary. The IMF should return to it original mandate and lend to countries (rich or poor) facing short-term balance-of-payments problems. In providing balance of payment support, the IMF would need to impose only a few conditions dealing strictly with core macroeconomic problems and with repayment of the loan. Longer-term development lending for the poorest countries is better left to agencies with the appropriate mandate and staff expertise, such as United Nations agencies and the World Bank.

The IMF should continue its mission of providing economic surveillance over member countries. However, this role should be expanded to include one important component of good economic governance: the monitoring of private capital flows. In the late 1990s, volatile movement of private capital repeatedly played a major role in undermining stability of economics in Asia, Russia, Mexico, and other economic crises. However, although it is appropriate that the IMF track capital flows, the IMF should not step in and bail out banks and private lenders who knowingly took risks investing overseas.

Good global governance means that speculators and bankers should not get special treatment. Rather, to ensure good governance, the IMF needs to create an independent, rules-based system that equally balances a country’s human needs and public services with obligations to creditors. To date, decisionmaking has been dominated by the finance ministries from the U.S. and other wealthy countries who are primarily concerned with protecting investments by international corporations.

In addition, the IMF needs to create an independent debt adjudication board to deal with the problems posed by mounting international debt in most poor countries. This board would be similar to U.S. bankruptcy courts and would help to establish a rules-based system. The U.S. should give such an alternative proposal due consideration.

As the IMF reins in its activities, it must itself adhere to principles of global economic governance. One step would entail freer access to information. Drafts of loan documents should be made public, so that civil society has an opportunity to voice concerns about IMF loan programs. IMF staff assessments of country economies should be regularly available. The U.S. can play a strong role in ensuring that these reforms are implemented.

In addition, IMF governance would be improved by making the board of executive directors more democratic and more accountable for decisions it makes. The executive board’s process of reaching decisions by consensus means that it is difficult for outsiders to verify the position of a particular country’s representative. A former U.S. executive director admitted in an April 1998 congressional hearing that, in 2,000 decisions she had been part of, she had only formally voted about twelve times. At a minimum, minutes of board meetings should be made available expeditiously, and board votes should be public. However, improved democracy and representation will not be achieved without a significant change in voting power of countries within the board. For instance, population size rather than the amount of money a particular country contributes to the Fund help determine a country’s voting share, and no one country should have veto power at the IMF. In the short-term, European executive directors who vote for blocs of countries should allow more developing countries to occupy those board seats.

In an important step taken in 2000, the IMF established an independent evaluation unit that is to report directly to the board and is to be independent of IMF management. The office is now hiring staff and formulating its work plan. It is critical that this unit truly acts in an independent manner and that it is willing to tackle contentious issues. Reviews made by this unit should be public, as well as the executive board’s response or action plan for carrying out any recommendations made by the unit. The IMF should also establish a grievance office so people within a country can challenge an IMF loan programs if they believe it is flawed. This is missing from the current evaluation office’s terms of reference.

Finally, discussions between the IMF and a borrowing country must include the full range of government ministers and parliamentary leaders. Without the representation and agreement of a wide array of government authorities, IMF programs may not identify core problems, predict negative outcomes, or win broad support. Although any more than token public consultation is neither feasible for short-term lending nor absolutely critical if IMF conditions are narrowly defined, the Fund should pursue opportunities, through its resident representatives, to establish more regular, informal contact between IMF officials and the public, as well as the government, in order to better assess the economic situation in member countries.

Carol Welch is deputy director of international programs at Friends
of the Earth in Washington, DC, where she specializes in international
financial institutions.