Global Policy Forum

By Christopher Lingle *

By insisting that the International Monetary Fund (IMF) promotes an extreme form of free enterprise capitalism, some commentators believe it should be closed down. But 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 with large budget deficits that seek financial support from the IMF are instructed to increase the tax burden to reduce shortfalls in public revenues. It defies logic to suppose that encouraging government to take greater control over the economy, thus, promotes free markets.

Whether the IMF does (or does not) promote free markets, there are good reasons to shut it down. On the basis of current circumstances and its ongoing operations, global financial flows would almost certainly be no worse off were the IMF to be abolished.
Indeed, global markets might work better without it. Founded in 1945, the IMF was charged with fostering economic stability by providing emergency loans to members having trouble financing their balance of payments. But the financial system it was designed for began vanishing in 1971 when the gold standard ceased to exist.

At one time, the financial system and private capital flows operated within fixed exchange rates and capital controls, with most financial transactions occurring between governments.
Private financial participation was low. 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 bridge loans so that trade could continue.
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, debt owed mostly to private banks and foreign investors. However, the expectation of financial lifelines led both borrowing countries and private investors to be irresponsible. This led to serial defaults on debt, notably 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. Lenders became less cautious. This problem began in 1995, after Mexico received large loans to tide over excessive borrowing under a fixed-exchange rate system.
The IMF's ``lender-of-last resort" role also led lenders 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 limit.
All this contributed to financial failures in East Asia, Russia, Brazil, Argentina and Turkey towards the end of the 1990s. Even if we ignore the IMF's role in creating the conditions for East Asia's 1997 turmoil, its officials were asleep at the wheel when it occurred. They seem to sense trouble only after a crisis erupts.
By mid-1997, Indonesia, South Korea, Malaysia, the Philippines and Thailand owed about $274 billion to international banks. No alarms rang at the IMF when roughly $175 billion had a maturity of less than one year, with short-term debts exceeding liquid foreign exchange reserves by about $100 billion. Such large external imbalances and currency misalignments were unprecedented at the time.

There is, therefore, great irony in the IMF's claim that it helped resolve the disruptions of 1997. Offering a helping hand after knocking someone over is hardly deserving of applause.

Further, since most of its operating revenue comes from interest income, good times for global economies are bad times for IMF income. With so few economies in need of assistance today, the IMF has recorded a deficit (``loss") of about $106 million, as of April 2007, and that is expected to grow.
Were the IMF a private business, it would probably need to be bailed out. With about $315 billion at its disposal, the outstanding loan book (which once exceeded $100 billion) was at only $15 billion at the end of 2003.
Until it stumbles upon a ``crisis", the IMF tends to avoid applying pragmatic economics or commercial logic. The functionaries seem to prefer the use of diplomacy and what is dangerously close to doubletalk. ``Poor governance," for example, is code for high-level corruption.

The incentives that IMF officials create for others have contributed to distortions in global financial markets and will do so as long as it exists. Its resource managers are putting others' money at risk to be spent by still others, but those involved in either lending or borrowing are unlikely to be held accountable.
It is not difficult to draw the conclusion that the IMF introduces more imbalances and instability into global financial markets than it helps contain. Promoters of free markets should join leftist agitators in having the IMF shuttered.

About the Author: Christopher Lingle is a research scholar at the Center for Civil Society in New Delhi and professor of economics at Universidad Francisco Marroquin in Guatemala.