ADIOS, IMF? International Monetary Fund

Tuesday, December 15, 1998

The International Monetary Fund (IMF) has hundreds of billions of dollars at its disposal and is a major player in the economies of nations around the world. But just what does it do? Vinny Agarwall, Professor, Department of Political Science, and Director, Berkeley Asia Pacific Economic Cooperation Study Center, University of California, Berkeley, Michael McFaul, Peter and Helen Bing Research Fellow, Hoover Institution, Assistant Professor, Department of Political Science, Stanford University, and John Taylor, Senior Fellow, Hoover Institution, Mary and Robert Raymond Professor of Economics, Stanford University pose the question: Is the IMF's mission still valid, or does it do more harm than good?

Recorded on Tuesday, December 15, 1998

ROBINSON Welcome to Uncommon Knowledge, I'm Peter Robinson. Our show today, "The International Monetary Fund or IMF". We begin with, bills. Suppose, not that it would happen of course, but suppose you get a little behind in your payments. The gas company, the phone company...they're both attaching late payment fees to their bills. The credit card, the interest payments alone are looking gigantic. What might you do? Well, you might go to a bank, consolidate all your little debts into one staggering debt and take out a loan. What will the bank do? It might assign a loan officer to go through your finances and help you straighten things out and it will certainly assign a repayment schedule and insist that you stick with it, repaying your bank loan in an orderly way. Now suppose you're not an individual but a nation- Russia, South Korea, Indonesia, one of the many nations around the world that's behind in its bills. What does the nation do? It might go to a bank, the International Monetary Fund or IMF. And what does the IMF do? Send in a team of experts to help the nation straighten out its finances and assign a repayment schedule and insist that the nations stick with it. If the nation misses its repayments, there's not much the IMF can do. And that's the difference- if an individual gets behind in his bank payments, the bank will go after him. Try to take his car, possibly his house. But if a nation gets behind in its payments to the IMF, what's the IMF going to do? Try to take over all the cars in Russia? Of course not. With us today, three guests: John Taylor is a professor of economics at Stanford. John believes the very existence of the IMF encourages nations to be fiscally irresponsible. Vinny Agarwall is a professor at Berkeley and Michael McFaul, a professor of political science at Stanford, is also a fellow at the Hoover Institution. Vinny and Michael believe the IMF is an essential institution helping to keep the global economy stable. But even they grant that the IMF needs reforms.

TAKE THE MONEY AND RUN

ROBINSON No less a figure than former Secretary of State, George Shultz, has called for the International Monetary Fund to be abolished. Vinny, abolish it?

AGARWALL No [ROBINSON Why not?] I think we should reform it, not abolish it. It's very difficult to create new institutions de novo we should be very careful when we go about destroying institutions.

ROBINSON The IMF is a useful thing to have on this earth. John?

TAYLOR I agree it should be abolished. I'd liked to do it... [ROBINSON It should be abolished?] It should be abolished, I agree. And I'd liked to do it slowly in a way that takes some of the talents there and use it in a more effective way. There's lot of highly skilled people there and if they can be doing things in another venue it would be very appropriate.

ROBINSON Slowly, skillfully, wrap it up and shut it down.

TAYLOR Right.

ROBINSON Mike?

McFAUL Well, until you have a better alternative, until you have a new institution in place, I think it's too early to abolish it. But the notion to reform it and to change it's mandate...maybe it can still be called the IMF, but it might be doing something else. I think that's readily apparent and has to happen.

ROBINSON OK, two reformers, one sledgehammer. Vinny, can you explain to me briefly what the darn thing is?

AGARWALL Well I can go back to 1944 when it was created. It was part of the Bretton Woods system. The IMF and IBRD (International Bank for Reconstruction and Development) commonly known as the World Bank were both created to deal with post-war financial reconstruction and issues that in 1944 the U.S. and its allies expected that they would win the war, and they decided to create these institutions. So the IMF was oriented to short term balance of payments lending to deal with the immediate financial crises of stabilizing exchange rates.

ROBINSON To rebuild the world after devastation of war... [AGARWALL That's right] we've heard that plan. OK what does it do now?

AGARWALL Well now it's looking for a mandate in some respects but it's been involved with debt crises. It's been involved with helping to make loans to developing countries who are experiencing balance of payments crises. And it's there to help stabilize exchange rates to some extent.

ROBINSON I read, prepping for this show, that the IMF has, makes available to its members which are 185 countries drawing rights, whatever those might be, equal to about 195 billion, with a big "B", Billion, dollars. Where does the IMF get that money?

TAYLOR The IMF works like a bank or a credit union. Countries make deposits, like the United States makes huge deposits, the biggest depositor, and then those funds are lent out as the IMF sees fits.

ROBINSON So it's the American taxpayer that's on the line for some of those tens of billions?

TAYLOR That's true as a depositor in this credit union.

McFAUL You have to remember that sometimes they lend to people who are not very credit worthy. Russia is a good example that very few people I know think that Russia will be paying back its IMF loans in the near future.

ROBINSON So that's billions of dollars down a hole

McFAUL Yeah.

AGARWALL But the IMF does lend at an interest rate, let's not forget that the IMF makes money on its loans. It's not that they're giving the money away free. They're not an aid agency, they're a lending agency which imposes conditionality on countries. So I don't think there's been a case where the IMF has not recovered its money in any country.

ROBINSON Well let me go after that for just a moment. They've not failed to recover their money, they lend at an interest rate, that sounds like a pretty good commercial proposition. Why do you need an IMF? Why can't commercial banks step in if there's actual business to be done?

AGARWALL Because commercial banks have commercial interests and they have a herd instinct. If you look at many of these debt crises going back to the 1980s, the banks went in the banks went out, when the going gets rough they get out. In fact that's when the IMF should come in because the IMF can serve a stabilizing role to make sure that the banks and other financial actors don't just turn tail and run.

ROBINSON To whom is the IMF accountable? John?

TAYLOR It's really not accountable enough to anyone. I think that's one of the main problems- accountability is very diffuse. Of course the member countries contribute and therefore have voting rights and the U.S. has a large role in that voting, in fact the U.S. is probably the most dominant player in the decision making at the IMF and that's another issue that people, including myself worry about. It looks like the U.S. is doing things abroad under the guise of the IMF and that's disturbing.

ROBINSON OK, So it makes you nervous that there's this extra national organization which has real money behind. Tens of billions of dollars and very few people know exactly what it's up to or to whom it's accountable, and that makes you nervous.

TAYLOR In addition, the original role for the IMF was in a completely different monetary system. I think this should be emphasized Vinny, it was a fixed exchange rate system set up after World War II where countries exchange rates didn't fluctuate and you needed to have some support to maintain those exchange rates. But we gave up on that in the early seventies and since then the IMF has really been in search of a mission and I think....

ROBINSON A powerful international organization with 200 billion dollars hunting around for a mission. So just what has the IMF been up to?

RUBLE WITHOUT A CAUSE

ROBINSON Case study number one: Mother Russia, you're the Russian expert... give us a brief summary of the IMF's involvement in Russia over the past 5-6 years.

McFAUL Russia first of all illustrates I think some of the new missions that the IMF has gotten into. Nobody 20 years ago would have predicted that the IMF would be in the micro-management of budgets in post-communist countries and that's what they've gotten into. But in brief, the IMF and the World Bank and many other international lending institutions were brought into Russia to try to help Russia make the transition from a command economy to a market economy. Basically it was a bribe. If you want to think about it really bluntly.

ROBINSON It's the rich world bribing these people not to go back to communism.

McFAUL Russia has problems balancing its budget, right? It doesn't work. In this transition from a command economy to a market economy there's real economic downturn. The IMF comes in with karats, chunks of money, usually in billions of dollars and says if you do this, we'll give you this money now if you do this economic reform we'll give you this money. And they have been in this to and fro really for the last five years. The problem with it is that the Russians no longer believe that the conditionality that the IMF tries to impose upon them is real because they think "we're too big to fail, the United States government is not going to let us down". When push come to shove, Yeltsin can pick up the phone and say, "hey Bill I need this money now, I'm in a presidential election (and this happened in the spring of 1996), can you get me that money?" And a political decision is then made to bolster the Russian economy.

ROBINSON Give me an order of magnitude about the amount of money that the IMF has lent to Russia in the last 5 years say. 1 billion? 10 billion? 100 billion? What is it?

McFAUL Well more has been pledged than has given. The first big tranche in 1996 up to that point was 10 billion. There was then another very big package but only the first four and a half billion of that was transferred because then Russia had a market meltdown last August. And it doesn't make any sense to give money to this place today.

ROBINSON It's 14 billion dollars in that economy. Now let me ask this question-

McFAUL No but that's the problem, it's not in the economy. It's in Cyprus, it's in Switzerland, and that's the problem...

ROBINSON How does it get to Cyprus or Switzerland?

McFAUL Well, the money goes into the central bank and the central bank bails out its commercial banks that it thinks needs to be upheld and that money quickly is...

ROBINSON It sounds like a lousy racket to me...(AGERWALL Well...) you're going to defend it now?

AGARWALL Well I'm going to defend in it partial way. I'm not going to have an unadulterated defense of the IMF but we have to realize it's always a matter of alternatives. What is the alternative to the IMF? Are we saying we want Russia to go under? [ROBINSON Hold on...] That we won't lend them money anyways?

ROBINSON Let me put that one exactly to John Taylor..John, mental experiment- over the last 5 or 6 years the IMF gave Russia nothing. What is the state of Russia today? Better or worse?

TAYLOR I think it would be better. [ROBINSON How come?] I think it would be better at this point. Well as we just heard, the money, large fractions of that money went to places that didn't help the country at all. Moreover it reduced the discipline that the country would actually have in terms of repaying its debts and managing its economy more efficiently.

ROBINSON So the IMF is applying pressure on Russia to do what was in Russia's interest to do in the first place and it would've been far better if the Russians had been allowed to muddle through to that conclusion on their own. Right? (Exactly) Vinny, attack.

AGARWALL Well, if there were tanks rolling across the border to Germany I don't think we'd quite feel that way. I mean I think (and you think that's the likely alternative?) I don't say that necessarily but we look at the IMF as the IMF is supposed to solve all their problems and in the absence of the IMF the problem would've gone away. In the 19th century we did not have the IMF, countries went into default, debt rescheduling in Mexico went from 1825 to 1888. Do we want 63 years of debt rescheduling? I don't think that's such a great idea and the IMF does help expedite the debt rescheduling process. If you don't believe that that's useful and we can wait 80 years for the Russians to recover, I think that's a very dangerous situation. We have to remember the U.S. has very important political interest in Russia. They have a lot of nuclear weapons and a lot of the nuclear technology is finding its way into different countries so it's really a question of American policy- do we want to do something whether it's through the IMF or directly to help the Russians? And I think the IMF can be helpful as one of the instruments of our foreign economic policies.

McFAUL And it's precisely because the Russians understand that. That when push comes to shove we can say, "if you don't give us this money, we've got these nuclear weapons". That's the dilemma that the IMF is in. The IMF has been politicized in many ways, it's the control of the U.S. government, I would argue, that has been part of the problem of the IMF because it undermines its credibility as an economic actor and makes it look like it's the bank of the Clinton Administration.

ROBINSON Well you just raised an interested point you said that the IMF is bribing Russia. But the other side of that is that Russia is threatening us. So it's not a bribe, it's protection money and 14 billion dollars is pretty cheap. Pretty cheap if the alternative is a missile in Manhattan.

TAYLOR We don't pay protection money when the protection money is likely to make things worse. For example, money, as the word goes fungible, those funds went not only to Switzerland and other countries but they helped, they can help finance military operations in Chechnya for example. This is money where you can't really control where it goes.

ROBINSON Onto our next case study where perhaps the IMF has had more success than in Russia.

PESOS FROM HEAVEN

ROBINSON Case study two, Mexico. If there's a success story in the last few years of IMF intervention, that success story is Mexico. 1995- the markets, international markets believe the Mexican economy is finally straightening itself out under the presidency of Carlos Salinas. Lots of capital is flowing into Mexico and then suddenly, the markets take another look. Maybe the reforms aren't as deep as we thought and for one reason or another there's a kind of cascade and capitol flows out of Mexico very very quickly. The value of the peso plummets and Mexico is in an enormous crisis. And the IMF puts in about 30 billion dollars. Here we are several years later, the crisis is over, the 30 billion dollars has been repaid. Terrific! Right?

TAYLOR No, not right...The reason is that particular episode was caused by some policy mistakes in Mexico. Yes certain things were getting better but on the other hand you had this inflation continuing and inevitably the peso is going to devalue and depreciate and now it's going to make a lot of holders of debt have a bigger debt to pay back. So this crisis happened because of bad policy. It was remedied short term and certain holders of debt were bailed out including foreign investors in the United States and other countries. They were bailed out and that was good for them and made the crisis a little less severe at the time. But now the expectation is that thing will occur, that same kind of event will occur in the future. And in fact...

ROBINSON Meaning the IMF will step in to bail out other countries that screw up their own currency...

TAYLOR Exactly and in fact the next series of crises were worse than anybody ever imagined. Partly I think because as what you say as a success of the Mexican operation it looked good then but it demonstrated the potential of the IMF to bail out countries who are making these policy mistakes.

ROBINSON So there was actually too little pain inflicted on the elite in Mexico and on the bankers who supported that elite. They got away pretty much scot free, they were made whole.

AGARWALL Well I think that's kind of misleading...number one, it was not the IMF that built up Mexico, it was the 50 billion dollar package which the U.S. used, the IMF was one component of that and it's our national interest to bail out Mexico. There's so much concern about immigration in the United States I don't think, just as we talk about missiles, no one wants massive outflows of refugees out of Mexico if the Mexican economy collapses. Therefore again it's an American political interest to stabilize Mexico. Whether we do that directly through a $50 billion dollar package or we use the IMF to help us out, I think it's better to use the IMF to help us out in that package...

ROBINSON John, run the same mental experiment on Mexico we did on Russia. It's 1995, the peso is in the toilet and the IMF doesn't do a darn thing about it. What happens then?

TAYLOR More people would've lost money at the time than they did in fact. But I believe the recovery of the economy would've been much like it was. Basically you had a deep cutoff in that economy in terms of growth, it looked like the Great Depression in the United States. You would have that in about the same way but the economy would have recovered in much the same way.

ROBINSON You argue that in substantive terms the IMF didn't make much difference but it did in psychological terms because people who run third world countries and bankers who support them around the world have looked at it and said "ah, yes, yet again the IMF has stepped in and prevented anybody from feeling pain as a result of mistakes". That's your argument?

TAYLOR Yes.

McFAUL You've had a big demonstration effect as a result of Mexico if you look at what the IMF in involved in where it is involved and the numbers involved [ROBINSON Were the Russians paying attention to what took place in Mexico?] Yes, although they have better trump cards than the Mexicans because they have nuclear weapons.

AGARWALL If you believe that argument, which I don't believe, Then you would believe that the Koreans, the Indonesians, the Malaysians were all sitting around saying the IMF is bailing out Mexico so I think we'll follow lousy macroeconomic policy.. And that's not what happened....

ROBINSON Well, those countries did follow lousy economic policies in a crisis did ensue. Did the IMF respond appropriately?

HITTING ROCK BAHT-TOM

ROBINSON 1997- We have the Asian tiger economies: Thailand, S. Korea, Indonesia, the countries you just mentioned, growing very steadily , but there's a problem- they've pegged their currencies to the dollar. They're following different macroeconomic policies so their currencies, there's pressure on their currencies, there comes a moment in the currency markets when there are rumors that the Thais are going to devalue the Thai currency, the bhatt. The bhatt's abhatt to hit bhattom. And the currency goes flooding out of those countries. Another crisis occurs and the IMF puts together a bail out in the amount of at least 118 billion dollars, an amount that may climb to 160 billion dollars. Fine, go ahead Vinny, why was that a good thing?

AGARWALL Well because what was the alternative? We have to remember much of the debt in these countries was private sector debt. A lot of the private sector debt if you let that private sector...after all the American banks and the European banks a lot of other banks were turning pale. What we see in lending is if you believe that markets stabilize, they do stabilize , but over what time, over what cost. John Maynard Keynes said in the long run we're all dead. So, the point is over what time period do we want these countries to adjust? What the IMF does in a good situation is to reduce the cost that these countries have to bear and reduce the cost that we have to bear and reduce the cost that commercial banks have to bear in the United States. Now you say, well it's only rich bankers, don't forget where your pension is. Your pension, the average American worker has pension and those investments are going into a lot of these countries where the returns are high. So it's not that we're just bailing out rich bankers we're also bailing out our own pension plans.

ROBINSON I see, well I must admit that had some persuasive force..OK now, Dr. Taylor in all three of these instances- Russia, Mexico, and Asia what you get is the world currency markets push capitol in and then something goes wrong and the capitol runs like hell and gets out of those countries..and those countries are suddenly in a huge amount of trouble. Let me mention to you a proposal by your former colleague Joseph Stiglitz, now the chief economist at the World Bank, "There are big risks attached to short term capitol flows and the benefits are ambiguous" and Stiglitz has proposed that since sudden changes in capitol flows can cause recessions, governments may be justified in taxing movement of capitol just the way governments tax companies that cause pollution. What do you make of that?

TAYLOR I think it would be a terrible mistake to restrict capitol flows as suggested there. Capitol is how countries have been able to grow. To get in the way of that I think is a terrible mistake. If you thought about putting your money into Malaysia as an investor and then realized it's not going to be able to get out again it's going to make you very wary about putting your money somewhere else. So restrictions on capitol flows I think are very dangerous.

ROBINSON OK so haven't you just made an argument for Vinny's point? That is to say, you're going to leave the capitol markets free so capitol is going to go sloshing into markets and sloshing back out of markets and we need the IMF to smooth out the effects of this capitol rushing into one place and then running away from it. Sensible right?

TAYLOR Capitol is always moving around. You don't need the IMF to try to disturb it or react to it.. I think in the case of Asia another mistake the IMF has made and Professor Stiglitz would certainly agree with this, is the insistence that these countries move to very tight monetary policies- raise interest rates drastically, very tight fiscal policies and that made the situation worse.

ROBINSON In the absence of the IMF what would the government of Thailand have done? Flown in bankers from New York and ask their advice? Just how would the mechanics of it work?

TAYLOR Rescheduling of the debt is what had to be done. Massive rescheduling because people couldn't meet their payments, that was not interest rate payments weren't being made, so we had to reschedule that. That rescheduling would've been done with the private sector and the government to the extent that they were involved and it would've been more difficult for the private sector because more people would've been out of more money.

AGARWALL Rescheduling- I've written on this in a book called "Debt Games". Over the last 200 years I looked at all these rescheduling arrangements in Mexico, Brazil, Argentina, and the like. Without international institutions, rescheduling takes a long time. Now if we're willing to wait around for 50 years for rescheduling to take place I agree, it will take place. Eventually we'll come to a rescheduling agreement. But we can't afford, as a, for a government policy, for consumers, for tax payers, for those countries' consumers and those countries' tax payers, they can't afford that.

ROBINSON Vinny isn't alone in arguing in support of the IMF. So does one very powerful private investor.

SORO'S INFORMERCIAL

ROBINSON George Soros- billionaire trader, who after all his billions of dollars indicate that he knows a little something about markets, writes this, "The private sector is ill-suited to allocate international credit . It provides either too little or too much. It does not have the information with which to form a balanced judgement." Therefore we need the bankers at the IMF right Mike?

McFAUL Well the assumption there is that somebody else will have the better information to make those assessments. And I'm not so sure I know of the institution, it most certainly isn't the IMF in the cases that I know. Though we have better information to make those judgements. However I think Soros does point out something that's very important at least in the post- communist world. When you look at the close of capitol, capitol moves much faster than the state is ready to. And information is superior in the market than it is in the state. The state is slow to respond, the state has to deal with domestic political constituencies and therefore money moves out faster and the state has really not kept up, if you will with these capitol flows.

AGARWALL Raises the question of what's known as the "lender of last resort". And I think that is the question that we've always been, that we've been actually talking about indirectly. A lender of last resort is some institution or some body that comes in and when things are really bad and banks don't want to lend , comes in and lends money to stabilize the situation. We have a lender of last resort in the United States it's called the Federal Reserve. The real question is do we need a lender of last resort in the international economy. If we don't believe we need one, then we have a serious problem because markets are going to take a long time to resolve these problems.

ROBINSON You who wish to abolish the IMF wish to deny to the world what we in the United States find essential to the smooth functioning of our own economy, a lender of last resort. You scrooge you.

TAYLOR Certainly not denied to the rest of the world but remember the Federal Reserve has lender of last resort responsibility for the U.S. monetary system. There are good reasons for that so that we don't have a collapse of liquidity like in the Great Depression in the United States. The lender of last resort is a very important role for a central bank, but Thailand has a central bank, Japan has a central bank, Mexico has a central bank and that's where the lender of last resort responsibility is for them in managing their own domestic economy.

ROBINSON Your reform is to abolish the IMF. Let me ask the two...Name one reform, what one reform would you make to improve that institution Mike?

McFAUL Transparency. We need to know more about how the IMF makes it decisions. That's the way you get accountability, is you know why they did it when they did it how they spent the money. Right now the IMF is a somewhat secret institution, very standoffish , "we make decisions" and I think that culture needs to change. In order for them, I think it's in their own interest because then it can build accountability and faith in those that invest in it.

ROBINSON What's your reform- one?

AGARWALL I'll have to give you two.

ROBINSON Oh all right give me two..

AGARWALL Cooperate with the World Trade Organization and the World Bank much more and hire some political scientists. The IMF has a very narrow vision of what the global economy is about and until they expand their vision of the global economy, hire some political scientists, some sociologists and some other people the kinds of policies that are designed will be very bad. They like to talk about giving medicine. Just yesterday I was reading Stan Fish who says, "Well we're just giving medicine to help them out." Well some people are allergic to certain kinds of penicillin and maybe they should think of which antibiotic they're going to use next time they try to bail out these countries. And I think that's what they don't think about because they treat everybody the same way.

ROBINSON OK predictions. George Soros, just quoted George Soros, actually wants the work of the IMF extended. He wants to create a big new organization he's going to call the International Credit Insurance Corporation to operate in tandem with the IMF. Choice number one, the Soros option- expand the work, give it a sister organization, increase its scope. Other choice, the Shultz option, the George Shultz option- abolish it. I'm going to ask you to close your eyes, transport yourselves forward in time ten years. Who has seen his option come to fruition? The Shultz option, wipe it out, or the Soros option, expand its scope? Mike?

McFAUL There will be a lot of domestic pressure in this country to reform if not abolish the IMF. I think that wave is growing. As we get into the next electoral cycle I think it will become one of the issues of foreign policy as a political issue I can see it playing in the next upcoming campaign.

ROBINSON Vinny? What happens 10 years from now?

AGARWALL Marginal reform. [ROBINSON Marginal reform?] I don't see that it'll go to either option. I think that the IMF will be around more or less in the same form it is ten years from now.

ROBINSON John?

TAYLOR I think we'll see a gradual reduction of the size and role of the IMF and perhaps merging in some way with the World Bank. And maybe eventually you'll see the mission go back to what it was originally which was to focus on countries that do fix their exchange rates say with the United States dollar, and that would be a very proper role.

ROBINSON Vinny, John, and Mike- thank you very much.

Vinny Agarwall and Mike McFaul want to reform but retain the IMF. They believe it's important to have a big extra national institution to help needy nations. John Taylor would be happy to live without the IMF letting needy nations go to the world's commercial capitol markets. But none of our guests doubt that money does indeed make the world go around. I'm Peter Robinson, thanks for joining us.