WASHINGTON, Oct. 4 (UPI) -- The International Monetary Fund, which met this weekend, plays an important role in third world finance, bailing out countries in difficulties and acting as an arbiter with private creditors. Unfortunately, it appears thereby to be doing more harm than good.
Nouriel Roubini and Brad Setser, two alumni of President Clinton's Treasury Department, have published a study "Bailouts or Bail-ins?" reviewing the past history of IMF country rescues, and proposing lessons for the future -- it was reviewed at the Institute for International Economics Tuesday. Both the speakers and the audience were favorably disposed towards the IMF's activities in this regard; I did not share their enthusiasm.
While the IMF's failure to restrain Argentina's behavior towards its creditors is notorious, it would claim credit for apparently successful bailouts of two large debtors that when bailed out were in similar difficulties to Argentina, having excessively high burdens of foreign debt and a liquidity crisis: Turkey and Brazil. Both countries were bailed out by the IMF in 2002, and both countries currently appear to have put their economic and financial position on a sounder basis, with a substantially positive budget balance before taking account of debt interest payments.
However, in both cases, interest payments make the actual budget balance heavily negative, a fact that is insufficiently stressed in discussing these economies' potential future. Year by year, they simply add to their overall debt, while only in years of very rapid economic growth does its burden decline as a percentage of gross domestic product. Furthermore, in neither Brazil nor Turkey has a significant percentage of the IMF's very large loans been repaid to the Fund; thus the hopes that these economies could rescue themselves by access to the private markets have not been fulfilled and "bailouts" that were intended to last only a couple of years are looking very much more like long term debt commitments.
If Turkey and Brazil have taken on such huge obligations that, given the constraints of politics, it is impossible for them to repay their debt and improve their overall position, then the IMF's bailout mechanisms are questionable at best. In that event, the three largest of them -- Argentina, Brazil and Turkey, would have merely prolonged the crisis and left the countries concerned with an even greater burden of debt.
Here the jury must be out, for the moment. Brazil has been through debt crises many times before, getting a previous IMF bailout in 1998, and is showing no signs of structural improvement in its economic and social policies, so one must remain provisionally of the view that the current lull in alarm about Brazil is no more than that and that within the next year or two a new Brazilian debt crisis will erupt, no doubt accompanied by fierce populist rhetoric about "neo-liberalism" from President Luis Ignacio "Lula" da Silva. At the moment, therefore, one's provisional opinion must be that the IMF's money pumped into Brazil has probably disappeared down a rat-hole, along with well over $200 billion of the world's finite supply of private capital.
In Turkey the outlook is a little more optimistic. Prime Minister Recep Erdogan, in office since December 2002, has a large majority in parliament and represents a force of moderate Islamism that had been locked out of Turkish politics for three quarters of a century. Politically, he is pro-Western, attempting to join the European Union and helping settle the long-running Cyprus dispute, while preserving an independence option if EU membership is refused. In economic policy, he is mildly reformist and pro-market, while distancing himself from the wholly pro-IMF policies of his election opponent and predecessor, former World Bank official Kemal Dervis. He may also be significantly less corrupt than his predecessors, although at this early stage in his premiership it's too early to tell.
Unlike Lula, therefore, who represents forces largely opposed to the free market and is hampered thereby in paying more than minimal respect to its tenets, Erdogan offers a chance of significantly faster economic growth, accompanied by reform and a shrinking of Turkey's bloated and corrupt public sector. Should this happy but still somewhat unlikely outcome take place, the IMF bailout of 2002 could be said to have succeeded.
It should be noted, however, that the IMF bailout of Turkey was structured to help not Erdogan but Dervis, his 2002 opponent, a man who has frequently confessed his continued taste for the mindless radicalism of the 1960s. Thus if the bailout succeeds, it will be pure accident!
There have been some smaller cases (Uruguay, Thailand) where an IMF bailout can be held to have succeeded, as well as one large success -- its first bailout of this type, Mexico in 1995 -- and one unquestioned failure -- Russia in 1998, where the country began economic recovery only after the IMF had left it.
Overall, however, the IMF's bailout record is at best very mixed, and its activities in this field suffer from two enormous disadvantages: (i) they lead to "moral hazard" that hugely distorts the activities of the private loan market, and (ii) by providing a bailout for unsatisfactory economic policies, they delay economic failure until it will no longer be identified in the mind of a democratic electorate with the bad policies that caused it.
The IMF's "moral hazard" comes from two sources. One, well recognized by the IMF, is that private lenders to countries with an IMF program in place may rely excessively on the IMF's control mechanisms, thus lending more money than they should. There certainly seems to have been a good deal of this in bond market lending to Argentina in 1995-1999, when the IMF's approval of Argentine economic policies was heavily marketed to sell Argentine bonds of as long as 20 years' maturity, a preposterous term for lending to a country with such historic instability.
The second, and far more pernicious moral hazard comes from the operating methods of the international institutions. Private sector debt is effectively subordinated to their obligations in a restructuring, and new money may even be made available by them. Thus countries such as Russia in 1999 and now Argentina who wish to bilk their private creditors can do so, provided they remain on civilized terms with the IMF bureaucrats, without any threat of being cut off from international finance, as would be normal for a borrower that defaults.
This removes the private creditors' principal bargaining weapon and makes default to private creditors an only too attractive option for the populist and immoral such as Argentina or the simply ruthless such as Russia. The official representative of the German bondholders of Argentine debt was present at the IIE meeting; he didn't get anything like the level of sympathy and support he should have, although admittedly buyers of 20 year Argentine bonds in 1998 acted with positively dot-com-investor levels of stupidity.
The IMF's propensity to delay economic disaster is if anything even more serious than its creation of moral hazard. In Brazil, the debt problem's underlying cause was the socialist constitution of 1988, which locked in the jobs, earnings and pensions of the (relatively well paid) Federal and state public sectors at the expense of the rest of the economy. It was exacerbated by the country's exchange rate peg to the dollar, which was wholly incompatible with the sloppy populism of President Fernando Cardoso's first term in 1994-98. Had Brazil been allowed to default in 1998, therefore, and have suffered the hardships consequent on being cut off from international finance, there would have been a good chance that blame would have been placed where it belonged. Instead, if Brazil defaults in 2005 or after, blame will be placed by the right on Lula and by Lula on the free market, not something that has ever really been tried in Brazil, and of course on the IMF itself.
In Argentina, the problem's even worse. Absent the IMF, the country would have defaulted in 1997 or so, at which point the poison of Peronism, that has impoverished Argentina for half a century, might finally have been discredited and replaced with something better. Instead, it defaulted in December 2001, destroying an admittedly incompetent Radical government that had been elected on a platform of greater public spending, but which represented the principal institutional rival to Peronism. The result in 2003 was the election of yet another Peronist, of a still more pernicious kind, on a platform of international default and internal socialism.
In both Brazil and Argentina, the wasted IMF money (which really belongs to the world's taxpayers) of the bailouts from 1998 on has been accompanied by considerable additional private sector money, lured into the trap by apparent IMF approval. The waste of world resources resulting from the bailouts is thus almost but not quite as regrettable as the diversion in the minds of the local electorates of responsibility from where it belongs.
There is a better way. Before 1914, there was no IMF. More recently, before about 1980, there were no IMF bailouts of Third World countries. Mark Weisbrot, of the Center for Economic and Policy Research, has demonstrated pretty convincingly that the economic growth rate of the Third World in 1980-2000 was far lower than in 1960-1980. He draws from this the conclusion that the economic policies favored by the Third World in the 1960s, of autarky, protectionism and government investment in heavy industry were superior to the more free market policies that followed.
To a market-oriented economist, this is vanishingly unlikely. Much more plausibly, before 1980 the IMF did not provide bail-outs to them, so Third World countries found it difficult to get themselves into staggeringly heavy levels of debt that they were unable to repay. Further, bad policies had bad consequences, in terms of cut-off from the international capital market, in those days controlled by the world's major banks. Thus the market's correcting mechanisms were able to function effectively, and there was less spectacular mis-allocation of resources.
To the extent the rich world's electorates want to assist in the economic development of the poor world, they can do so directly, by providing grants of money and technical assistance. The IMF, which provides pretend-loans that countries have no real need to repay, is operating a Ponzi scheme to the benefit of its staff and of the most populist and immoral Third World governments. It should be closed.
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2004) -- details can be found on the Web site greatconservatives.com.