Old Challenges for New IMF Chief

by Berly

One of the old challenges Mr Strauss-Kahn should immediately addresses, ironically, is the mechanism how he received his post. An unwritten rule establishes that the IMF's managing director must be European and that the president of the World Bank must be from the United States. The practice is increasingly questioned since IMF policy affect developing countries significantly more. A developed country in financial crisis can afford not to take IMF advice and loan since their access to financial market are not drying up. IMF usually become the main, sometime the only, source of fund for developing country in crisis and exerted enormous influence.

The voting weight of each IMF members are determined by the amount of money a country provides to the fund relative to the size of its role in the international trading system, but the relative size reflected each economic prowess more for the time IMF was founded than today. Europe is over represented and US practically held a veto with its 17 % vote since major decision require 85 % support. In 2001, China was prevented from increasing its quota to reflect rising share of its economy ensuring it remained at the level of the smallest G7 economy. Under leadership of Rodrigo de Rato, China contribution has been allowed to be increased slightly further.

The second old challenge is the role of IMF. The Great Depression were characterized by bank run caused by panic investors and IMF was supposed to act as lender of the last resort to prevent systemic meltdown at international level. Recent studies (Banerjee, 1992; Lux, 1995) in behavioral finance has shown that herd behavior to sell investment at the first hint of trouble is a self fulfilling prophecy that precipice the crisis it fear.

Each member country entitled to withdraw a percentage of its quota immediately in case of payment problems meaning developing country has quick access to less fund just where the need is greatest. When a member country in need of financial infusion, IMF should act like a central bank in similar situation. Lend freely with penalty, slightly higher interest rate than usual, for a temporary period.

IMF tends to overestimate the ability of high interest rate to attract investment after crisis despite the empirical evidence otherwise (Sach, 2005). The structural adjustment program and fiscal austerity to repay the loan, normally in full value despite principle of share responsibility, typically disproportionably affect the poor population and caused political instability which heighten and prolonged the crisis IMF supposed to ease in the first place.

Evading the policy strait jacket of IMF lead developing countries to accumulate huge amount of reserve, mainly in form of US Treasury bill, to defend their currency in the face of speculative attract. Southeast Asian nations have been developing a regional cooperative to share foreign exchange reserves in the event of a crisis. But developing countries received low return from T-Bill and the opportunity costs are calculated to be 300 billion dollar per year (Stiglitz, 2006). The amount is more than four times the total foreign assistance in the world and could have been used to reduce poverty and increase education/ health expenditure if IMF properly conducts the job it’s designed to do.

As finance minister in Socialist government from 1997 to 1999, Mr Strauss-Kahn challenged his party orthodoxy and cut the public deficit to qualify France for the euro. Let’s hope that he still got the backbone to challenge Washington Consensus orthodoxy as IMF Managing Director. The world certainly need, and deserve, a better IMF.

IMF is watching you

by Berly

The Jakarta Post (TJP) published a letter from IMF yesterday (click here). It’s not a new Letter of Intent since Indonesia already out of “intensive care.”

The letter is supposed to be a rebuttal of Stiglitz interview (for transcript click here) published earlier in TJP. The letter was signed by Daniel Citrin, Deputy Director of Asia and Pacific Department, which is higher than country director (see organizational chart here) but not still not count as Senior Officials (see compete list here).

Before we deal with point by point rebuttal to IMF, let’s start by point out that the interview was published on June 5 instead of June 6 editions.

Their first rebuttal is pointing how the regional economy is booming. One of the most common logical fallacy is “post hoc ergo propter hoc.” For non Latin readers, it means assuming that if one event happens after another, then the first must be the cause of the second. So if East Asia countries are booming after being under IMF treatment, then the prosperity must be because of IMF. Too bad that if we include China and Malaysia (which did not gone through IMF and also booming now) the claim loose much of its strength.

Their second response is to claim the Fund's response to the crisis contributed to the region's rebound. IMF claimed (read here) that they resolve the crisis (yup, that is the title of the document) by “ensure that the funds will be used to resolve the borrower's balance of payments problems. They would also help to restore or attract access to financial support from other creditors and donors”.

What about the conditionality? Some of the performance criteria (read the complete list here) are “macroeconomic policy variables such as international reserves, monetary and credit aggregates, fiscal balances, or external borrowing.”

Their third, and the lamest, is to state that the IMF is a constantly evolving institution. “As part of this process of reform, the approach to crisis prevention and crisis resolution has changed over time, reflecting the lessons learned.” To read in plain English, “we f****ed up before but we would not do it again. Just trust us.”

And what actually Stiglitz said that prompt the honorable deputy director to react so swiftly? Let me quote at length two important questions and his reply:

“As a steadfast critic of the IMF, what would you suggest to the IMF to make its future policy advises work better?
The problem is that when a country goes into a downturn, it is told to cut back on expenditures and raise interest rates. Their policies are what we call pro-cyclical, that exacerbate the downturn. What I advocate is a counter-cyclical policy: When you lend money to a country, you tell them to keep interest rates low and to keep taxes low to stimulate the economy. So, you have a loan that would stimulate the economy so that the economy could grow.

But the IMF loans are to strengthen reserves, not to finance economic activities.
That's why their loans do not help the economy recover from a crisis, that's exactly the problem. Their finance focuses on financial stability than real stability. They have to focus more on real stability.”

Hmm… it sound very similar to first year macroeconomics course I had (and as I am studying at post-grad level, still recommended at most cases of depression as long as not causing high inflation). Lord Keynes proposed it more than fifty years ago and it is one of few policy prescription that has been followed closely by western countries. But it is exactly what the policy that IMF asked countries in crisis NOT to do by insisting to reduce government expanditure (which worsen impact to the poor) and increse interest rates (which fail to reduce capital flight and bring new investment in short run, when it is most needed).

As a former chairman of Economic Advisor to President Clinton that oversaw longest economic boom in American recent history and chief economist of World Bank (as well as OECD), Chairman Joe has his own experiences and opinions. Too bad he was never chief economist of IMF. Maybe IMF will be watching it's own member's economies and taking care of it more than being so busy watching its own reputation.

For more sharp analysis on IMF usefulness (and uselessness), read an excellent short piece by Paul Krugman here.