Fatal flaws in IMF's remedies for crises
Sunday 08 August 1999
Once upon a time, we thought we knew that worldwide financial crises came roughly every 50 years. The 1880s, the 1930s, the 1980s, ... the 2030s? Evidently not. Mexico's crisis came 37 years too soon, and only three or four years after the 1980s crisis had supposedly been resolved. Since then, four crises in less than five years have each had a devastating economic and social impact affecting hundreds of millions of people.
The "new" crises are different in nature, too. Where previous crises arose from foreign debts owed by governments, the recent ones have arisen mainly from various kinds of private-sector liabilities: commercial debts of private companies; foreign-owned shares; foreign deposits in and loans to banks; and (arguably) investments by transnational companies.This difference reflects fundamental changes in international finance. Lending to developing country governments has become unfashionable since (and largely because of) the 1980s. Now, the only way of financing development is through commercial flows to the private sector. And this path has been actively promoted by requirements in IMF and World Bank structural adjustment programmes to remove controls on all kinds of capital flows.
The problem is that most private-sector financial flows are expensive and volatile, which makes them unsuitable for most developing countries. Unregulated financial markets are inherently unstable. They are prone to herd behaviour by investors, speculative bubbles, and crises fuelled by self-fulfilling expectations. That is why we regulate financial markets at the national level. Otherwise their vagaries would risk overturning the real economy.
The opening of national financial systems has created a globalised financial market, but we have not developed the market infrastructure at the international level to make it work. This is fundamentally what has generated the new crises. We have created a world in which devastating financial crises in developing countries have become endemic. The trouble is that the international community is seeking to push the world economy still further in this direction.
The IMF wants to extend its mandate to push its members towards complete deregulation of international capital flows; and the OECD is trying to set up an alternative form of the Multilateral Agreement on Investment - effectively a charter for foreign investors - through the World Trade Organisation. These proposals seem to be on hold, but they have by no means gone away. As they are now envisaged, they would merely serve to make future crises still more inevitable.
While the new crises are different, the international system's response has been just the same as in the 1980s, based on loans to the government concerned from international agencies and the developed country governments, subject to conditions on economic policies. Even the policies which are imposed have barely changed.This approach has failed spectacularly.
As a response to the new financial crises, this approach is quite simply incoherent. Apart from the counter-productive policies which were imposed, the financial mechanisms mean that it cannot work. The new crises simply happen too fast. When the crisis strikes, massive amounts of foreign exchange leave the country quickly and the government can do almost nothing to stop it. Suspending payments on government debts would do more harm than good; and, unlike the 1980s, governments cannot readily restrict the outflow of capital from the private sector because the mechanisms for such restrictions have largely been dismantled. The Malaysian government tried this, and was met with a barrage of international opprobrium.
So billions of dollars can leave the country in a matter of days. But putting together a "rescue" package can take weeks, while the IMF designs, negotiates and approves a policy programme, and negotiates contributions with governments and other international agencies, and each contributor completes its own political and bureaucratic procedures. By the time the money arrives, billions of dollars have flooded out of the economy, and the damage has become irreparable. Conditionality makes things worse. It also undermines the crucial effect on market confidence, because the rest of the money will be paid only if the conditions are met.
The result is a serious danger that the money would be too little and too uncertain even if it weren't too late. More fundamentally, the cost of the rescues is borne by those governments that provide the loans, and those which ultimately have to repay them. This shifts the financial burden from private lenders and investors, who sought large profits in return for risk and lost their bets, to taxpayers. This is not only inequitable: by limiting the costs of the crisis to those who helped to cause it - encouraging them to do the same thing, and cause the same kind of crisis again. Where governments need to borrow, lending to them makes sense. But the Asian governments didn't need to borrow until they suffered the disastrous consequences of the delayed, inadequate and inappropriate attempt to rescue them. Even if enough money could be provided when it was needed, it would still be provided in the wrong form.
What is needed is a different approach to a very different kind of crisis - a mechanism to provide enough of the right kind of support when it is needed, without increasing the risk of future crises. This is what the Catholic Institute for International Relations is proposing. The centrepiece of the proposal is a Global Intervention Fund (GIF), financed by a "Tobin" tax - a tax levied internationally at a low rate on all foreign exchange transactions. When a country's foreign exchange reserves fell below a certain threshold, the GIF would automatically defend its currency, in the same way the Bank of England defends the pound. The only policy condition would be an acceleration of the rate of depreciation within a crawling peg system.
This approach has potentially enormous advantages. It would operate to prevent crises, rather than to pick up the pieces after most of the damage has been done. It would avoid the massive and disruptive exchange rate over-shooting, as seen in the recent crises. By avoiding sudden large devaluations, it would reduce the incentives for currency speculation and limit economic disruption. And it would prevent private-sector crises being turned into public-sector debts.
The international community should consider proposals such as this as a matter of urgency. In the Asian crisis, it acted like a doctor who unthinkingly prescribes his patient the medicine which happens to be on his desk from the previous patient, who had a different illness. To do this once may be excusable, if it was the only medicine available and the doctor thought it was better than nothing. What is inexcusable is that the doctor is still in his surgery, waiting to do the same thing to his next patient - this time consciously and fully aware of the fate of his last victim.
n David Woodward has been an economic adviser to the Foreign Office and technical assistant to the British executive director of the IMF and World Bank. `Time to Change the Prescription: a Policy Response to the Asian Financial Crisis' is available from the Catholic Institute for International Relations (CIIR) (tel: 0171-354 0883), price pounds 3.
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