Time to close the IMF

The Jakarta Post ,  Jakarta   |  Wed, 10/24/2007 4:17 PM  |  Opinion

Christopher Lingle, Denpasar, Bali

Last weekend, the world's finance ministers met in Washington for the annual meetings of the World Bank and the International Monetary Fund. This would be a fitting time to examine why the IMF should be shuttered.

Interestingly, many left-wing commentators seek closure of the IMF on the grounds that it promotes free enterprise capitalism. Considering the IMF's record, one has to be hooked on hallucinogenic drugs to believe it holds a corporate view in support of economic fundamentalism.

As it is, governments seeking financial support from the IMF have large budget deficits are instructed to increase tax rates or levy new taxes to reduce shortfalls in public-sector revenues. It defies logic to suppose increasing the tax burden so that governments have more control over the economy promotes free markets.

Having said this, there are good reasons to shut down the IMF. On the basis of current circumstances and its ongoing operations, global financial flows would almost certainly be no worse off the IMF were abolished. Indeed, it is more likely that global markets would work better without it.

Founded in 1945, the IMF was charged with fostering economic stability by providing emergency loans to members with problems in financing their balance of payments. But the financial system it was designed to oversee began disappearing in 1971 when the gold-exchange standard ceased to exist.

At one time, financial system and private capital flows operated within fixed exchange rates and capital controls with most financial transactions occurring between governments. And there were no private financial institutions able to muster financial resources to fund large government projects.

Under these conditions, the IMF provided temporary relief from upheavals that might disrupt international trade. Since countries with fixed exchange rates tend to encounter problems with foreign exchange liquidity, the IMF provided bridging loans so trade could continue unabated.

But floating exchange rates and open capital markets with greater macroeconomic stability from globalized capital markets and institutional competition undermined its raison d'etre. In response, highly-paid bureaucrats engaged in ""mission creep"" and expanded the role of the IMF beyond its original brief.

And so the IMF began bailing out countries with excessive debt, mostly to private banks and foreign investors. However, the expectations of financial lifelines led both borrowing countries and private investors to be irresponsible. This led to serial defaults on debt like Brazil (seven times), Argentina (five times), Venezuela (nine times) and Turkey (six times).

The ""moral hazard"" created by IMF bailouts reduced the costs of making mistakes and lowered the likelihood and extent of losses so that lenders tend to be less cautious. This problem began in 1995 after Mexico received large loans to bail out excessive borrowing under a fixed-exchange rate system.

Acting as a global ""lender-of-last resort"" softened punishments to borrowers while lenders were led to believe they would not suffer much if there were defaults. This created distorted incentives that led to larger financial problems while eroding the sense that IMF funding had a clear, upper limit. These actions certainly contributed to financial failures in East Asia, Russia, Brazil, Argentina, and Turkey toward the end of 1990s.

Even if we ignore the fact they had a role in setting up conditions that led to the financial turmoil that hit East Asia in 1997, IMF officials were asleep at the wheel when it occurred. It would appear that IMF officials sense trouble only after economies begin unraveling!

It seems to have gone unnoticed that by mid-1997, Indonesia, South Korea, Malaysia, the Philippines, and Thailand owed about $274 billion to international banks. And no alarms sounded at the IMF when roughly $175 billion had a maturity of less than one year so that short-term debts exceeded liquid foreign-exchange reserves by about $100 billion. At that time, such large external imbalances in global international payments and extensive currency misalignments were without precedent.

There is great irony in IMF claims site that it helped resolve the economic and financial disruptions that occurred in East Asia in 1997. The claim is like someone throwing manure on another and then expecting to be thanked for helping them get rid of flies that gathered!

Since most of its operating revenue comes from interest income from loans it makes, good times for the global economies are bad for IMF income. With so few economies in need of assistance, the IMF is on such hard times that it recorded a deficit (loss) of about $106 million as of April 2007 that is expected to grow.

Were the IMF a private financial institution or business, it would probably be in receivership. With about $315 billion at its disposal, the outstanding loan book that once exceeded $100 billion was as low as $15 billion at the end of 2003. Until it stumbles upon a ""crisis"", the IMF assiduously avoids applying hard-headed economics or commercial logic that is replaced by diplomacy and double-talk. For example, IMF officials use poor governance serves as a code word when referring to high-level corruption.

Given the incentives that IMF officials face and create for others has contributed to distortions in global financial markets and will do so as long as it exists. As it is, well-paid functionaries put others money at risk to be spent by other people but those involved in either lending or borrowing are unlikely to be held accountable. So the mistakes will go on and on.

Since the IMF actually introduces imbalances and instability into global financial markets, promoters of free markets join with leftist agitators in hoping that the IMF be shuttered.

The writer is Research Scholar at the Centre for Civil Society in New Delhi and Professor of Economics at Universidad Francisco Marroquin in Guatemala. He can be reached at Clingle@ufm.edu.gt

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