When Dominique Strauss-Kahn, the managing director of the International Monetary Fund (IMF), announced on 15 December that in this time of crisis “it is fiscal expansion, not fiscal contraction, that we need”, he broke rank with 30 years worth of IMF dogma and advice. IMF’s position has always been that crisis in a country can be resolved through fiscal contraction which would minimize interference by the government and, thereby, allow the market to find the best solution. That the fund is recommending fiscal expansion is, quite frankly, groundbreaking. Strauss-Kahn on 10 December noted that it had “plenty of funding” to aid countries in creating these expansionary policies, and the world of development financing shook. The question is this—why is IMF changing its opinion so drastically and does it have any substance?
Countries in a financial crisis are usually able to borrow money from IMF as long as they agree to a set of conditions referred to as the “Washington Consensus”. These conditions generally include liberalizing financial markets, privatizing public companies and reducing fiscal expenditure. IMF has implemented these policies across the world with ruthless efficiency, often by making new legislation a requirement for loans.
This was seen in Thailand, after the 1997 crisis, where IMF loan conditions were passed into law by the National Assembly through four emergency decrees without parliamentary debate. South Korea had an election as IMF put forward its recommendations, which included one particular condition to reduce the (soon to be privatized) banking sector’s workforce by 50%. IMF flatly refused to release any funds until all presidential candidates agreed—in writing—to abide by all IMF conditions, even if the candidates ran on an anti-IMF platform. Across the board, these conditions called for liberalizing capital markets and fiscal contraction in the face of recession.
IMF is now getting ready to recommend the polar opposite. Governments should intervene in financial markets on a national level, according to a new policy paper due in 2009, and IMF is publicly recommending the injection of 2% of global gross domestic product (GDP)—Rs57 trillion—through national fiscal stimulus packages. But why?
The most obvious reason for these announcements is that IMF has been losing trust as well as business across the world since 1997. Consider that disbursements by IMF have fallen by 90% since 1995, when it lent Rs93,800 crore globally, to only Rs7,800 crore in 2007. Even IMF’s own Independent Evaluation Office concluded that trust had been lost as the conditions on the 1997 crisis loans had been “ill-advised…(and) not critical to resolving the crisis”.
So, to rebuild its image as a responsible policy maker, IMF appears to have jumped on the fiscal spending bandwagon which started with the US bailout package and spread to the UK and EU. That IMF should support the actions of the majority of its donors and its current president’s home should come as no surprise, but will it recommend the same action for its borrowing clientele?
This is where IMF’s rhetoric comes undone. It has recently approved four financial crisis packages to Hungary, Iceland, Ukraine and Pakistan, and across the board it is advising cuts to the public budget. Ukraine is expected to cut its fiscal deficit by 5% of GDP in a single year through public expenditure reductions and higher energy taxes. Hungary must reduce the “overall government wage and pension bill. Nominal wage adjustments will be postponed and pension bonuses suspended”. Iceland has been spared fiscal cuts until early 2010, but is already in a recession, so IMF has liberalized Iceland’s current account while recommending higher interest rates. Pakistan, in turn, must cut public expenditure and tighten monetary policy to collect its loan.
The most recent package, approved for Latvia on 23 December, calls for “substantial fiscal policy tightening” and the fund will not take a decision on El Salvador’s request for crisis funding until after the El Salvadorian election. The local mission chief, Alfred Schipke, has already met the main presidential candidates and ensured all of their endorsement of the IMF plan, which is “anchored on maintaining a prudent fiscal stance in 2009”, so at least one lesson from South Korea has been learnt.
It turns out that IMF’s recommendation for government to intervene in the financial markets is nothing new. It discourages capital controls and government involvement, supporting transparency of transactions—a standard Washington Consensus governance requirement.
Moreover, the suggestion to spend your way out of a recession will not be supported in countries which are deemed to have “high levels of debt” or which have budget deficits. These are, of course, the two main symptoms of suffering from the current crisis, so if financial crisis is the disease, fiscal stimuli is not the medicine IMF will distribute.
Strangely, the fund sees no contradiction in the fact that it is pushing for global fiscal expansion and simultaneously calling for fiscal contraction in every client country where it has policy influence. IMF and Strauss-Kahn’s announcement is sadly nothing but empty rhetoric, aimed at building goodwill and maybe entice “some large emerging economies” (read China and India) to take up a loan with the new and friendly IMF. Buyer beware, it is the same old thing.
Benjamin H. Mitra-Kahn is an economist with the City University, London, and the New School for Social Research, New York. Comment at firstname.lastname@example.org