Rumors of the International Monetary Fund’s demise appear to have been greatly exaggerated. While the IMF has spent most of the last three years looking for clients and “relevance,” the end of the U.S. housing bubble and the resulting global credit crunch seem to have given the institution a new lease on life.
With this new chance to prove itself, the IMF should finally learn from its mistakes. Ultimately the institution most responsible for its recent lack of relevance is the IMF itself. By continuing to prescribe a one-size-fits-all, market fundamentalist cocktail for economies in distress, the Fund helped create the conditions for massive financial hemorrhaging that struck much of Southeast and East Asia in 1997, perhaps the most discussed financial crisis in recent memory. The IMF has also caused or exacerbated crises in Russia, Mexico, Turkey, Argentina, and other countries.
In a saner world, the IMF would change its tune and advise countries to build up their own economies — perhaps through some kind of green jobs plan — instead of rapidly integrating into a global economy largely built on U.S. consumption.
After all, of its four top borrowers in 2004 — Turkey, Indonesia, Brazil, and Argentina — only Turkey remains a borrower today. The others, following an example South Korea set in 2001, have repaid the IMF early to reduce interest payments free themselves from the IMF’s policy “advice.” A few months ago it looked as though the institution was on its way to a slow death as Turkey announced it had no intention to renew its IMF loan, endangering one of the institution’s last steady sources of income.
But all that has changed. The U.S. housing bubble has popped, and as a result a huge proportion of the world’s countries — those that built their growth strategy around selling to the U.S. market — are likely to go into recession. Some are facing severe shortfalls and need the kind of cash infusion the IMF can deliver.
Never mind that the IMF didn’t see the housing crash coming (despite overwhelming evidence); never mind that the IMF was the main proponent of selling to the U.S. market as a growth strategy; and never mind that the business press (and the IMF itself) admits that those economies that are decoupled from the global financial system are more likely to do well in this period.
It’s the IMF to the rescue! Again.
Same Wine, Same Bottle
So far three countries (Iceland, Hungary, and Ukraine) have benefited from a new round of IMF loans. Two others (Pakistan and Belarus) are also knocking at the door. These new loans provide a test: Will the IMF learn from its mistakes or continue to repeat them by demanding that borrowers embrace the policies of privatization, trade liberalization, currency liberalization, and budget cuts?
Both Ukraine and Hungary have had IMF programs in the not-too-distant past, while Iceland has been the poster-child of an extreme neoliberal economy for some years. So all of these countries should be in pretty good shape, at least according to IMF standards.
Ukraine approached the IMF weeks ago to raise money for its own bailout plan for its banks, something similar to what Treasury Secretary Henry Paulson orchestrated in the United States. The IMF was more than ready for a new client (it eventually lent $16.4 billion), but was concerned about the size of Ukraine’s debt-to-GDP ratio. Ukraine’s debt was seen as unsustainable at about 30% of GDP. Yet U.S. debt stands at more than 300% of its GDP.
To comply with the IMF’s loan conditions, Ukraine will have to cut its annual deficit down from 4.2% of GDP to 1%. Wages will be cut while the cost of essential services such as heating will rise by as much as 35% as fuel subsidies are eliminated. Currency restrictions will also be loosened, meaning that the cost of living will probably go up while the value of the currency falls. Tough times if you’re a Ukrainian citizen — unless of course you happen to be one of those banking executives to whom all this money will be going.
The situation in Hungary is similar. Hungary, which has a much higher debt-to-GDP ratio of about 97%, is being forced to freeze all public-sector wages, lower pensions and other benefits, and cut social spending across the board. Through these measures, the IMF hopes to move from a $1.38 billion deficit in March of 2009 to a surplus of $1.26 billion by September. Talk about tightening the belt.
These measures stand in stark contrast to those taken by the United States and other developed countries. While “green investment” and infrastructure expansion — which require a boost in government spending — are the tools of choice for rich countries, the IMF is still preaching austerity.
Iceland hasn’t only been the “first to fall” in the global financial crisis, it’s also been the hardest hit. Since the 1990s, the center-right Independence Party, which has ruled Iceland since World War II, has aggressively pushed IMF-style policies, including large-scale financial privatization and removing capital controls of all kind. It even went so far as to privatize the Icelandic genome. As long as the world was experiencing a global boom, Iceland’s dynamic financial services industry was the pride of Europe.
But the second that the boom ended, disaster struck. Iceland’s economy was so intertwined with a financial services industry that believed U.S. housing prices would never falter, that when the industry fell it took the nation with it. In an effort to stave off complete ruin, the government nationalized the three major banks and assumed most of their debt, some $60 billion or six times Iceland’s GDP.
On paper, Iceland’s situation is much more serious than that of Ukraine or Hungary. So why are the IMF conditions much less severe? Aside from a prescribed hike in interest rates, the country’s $2.1 billion loan has come without strings.
The situation in Iceland is reminiscent of the situation in Argentina, a former IMF “success story.” Until late 2001, Argentina was the IMF teacher’s pet. It had successfully privatized its financial system and most of its economy. Price controls were eliminated, as were tariffs and subsidies, meaning that cheap foreign goods flooded the market. Controversially, the economy was held in place by tying the Argentine peso to the U.S. dollar, a policy the IMF helped support by encouraging Argentina to acquire huge amounts of debt, much of it in the form of high-yielding bonds sold to foreign investors who didn’t believe the Fund would ever “let” Argentina default no matter how unrealistic the country’s financial picture became.
In December of 2001, that house of cards came tumbling down. Investors finally acknowledged that the peso as incredibly overvalued, and took their money out of Argentina causing a run on the currency. In early 2002, amid political chaos, Argentina wound up defaulting on about $90 billion in privately held bonds, largely belonging to foreign investors. It was part of a record $141 billion sovereign debt default. In 2003, it defaulted on payments to the Fund and World Bank (though it got back on track soon afterward). In early 2005, three-quarters of the country’s creditors accepted a deal that repaid them 30 cents on the dollar. To this day, it lacks access to the international capital markets and is still working on a deal with the holdouts from that deal.
The case of Argentina is interesting because of the advice that the IMF was giving at the time. When things got really bad, the IMF didn’t change its course. It insisted on severe budget cuts, interest rate hikes, and spending freezes long after everyone understood that the economy really needed a stimulus package. In short, they put the interests of Argentina’s creditors — who wanted their money back as soon as possible — over the interests of Argentina’s citizens who needed food and jobs.
Perhaps the case of Iceland does show some growth on the part of the IMF. Instead of demanding sweeping changes in exchange for huge sums of cash, the IMF is offering a relatively modest $2.1 billion and admitting that it’s not sure how to fix the problem. While there are signs that the IMF may be backing off its commitment, going through with the loan to Iceland would be more courageous. Humility would be a welcome change for the IMF, albeit a few decades late and still unevenly applied.
And it’s this track record on which the IMF should be judged as today’s financial and economic crises unfold. The IMF’s policy advice is always designed to reflect the best interest of investors.
While the Argentine case shows that even in that mission the IMF often misses the mark, the interests of investors and those of citizens are usually not one and the same. As the global financial order that has reigned since 1980 comes to an end, we would do well to design a system that fulfills the promises of documents like the Universal Declaration of Human Rights, which 60 years ago promised food, housing, health care, and education for all. The new economic system should place citizens’ needs over investors’ greed.
Such a new system can’t be led by the same old IMF. As French Economy Minister Christine Lagarde put it after a meeting of the Group of 20 nations in São Paulo, Brazil, many countries feel that the Fund has acted in a “very orthodox and imperialist” way in the past. “The old-school IMF has left some scars,” Lagarde said.
Let’s hope Lagarde and other leaders of the world’s economies can put the “old-school” IMF out of its misery and move on to real solutions.