Wednesday, March 18, 2009

IMF: The Devil Or Saviour?

IMF boss: Dominique Strauss Kahn

Basic facts about IMF (International Monetary Fund)

IMF is an international organisation that was founded in 1944. Its main aim is to promote exchange rate stability, helping countries to resolve their balance of payment imbalances & to provide financial loans to countries in crisis

The pool of funds in IMF comes from 185 of its member countries. The size of the fund can be increased by raising more from the existing members or with an increase membership. Also one should be aware that not all countries contribute equally to IMF. For instance, US have been consistently the largest contributor to IMF & thus having the largest voting rights

Are they the same? World Bank vs. IMF

By principle, IMF was established to help to stabilise international financial system by helping governments to overcome balance of payments (BOP) problems. Meanwhile World Bank or its proper name is IBRD (International Bank for Reconstruction & Development) has the role to give financial assistance for post-war reconstruction

Nevertheless, their role in the recent 2 decades have somewhat diminished. In 1980s & 1995, IMF had lent to Mexico, 1997-1998 to countries in Asia like South Korea, Thailand & Indonesia & Argentina in 2001. This are backed by additional funding from World Bank

Why IMF is so controversial?

Economists particularly from developing world condemned IMF for not having the pure intention of helping countries in trouble. Conditionalities such as SAPs (Structural Adjustment Programs) are viewed as the modern way of colonisation of local economy. It seems to be operating in the interest of large Western economies particularly US which has the largest veto rights & say. Also it seems that IMF has ‘profit motive’ more than anything else when they impose those changes

SAPs are policy changes implemented by IMF (also World Bank) onto developing countries as a condition for getting new loans, rescheduling of loans or negotiating for lower interest loans. Conditionalities are implemented to ensure that the money lent is spent in accordance with the objective of the loan that is to reduce fiscal imbalances

Among policy changes imposed on borrowers are:

(A) Fiscal austerity.
This means countries receiving the loan must undertake initiatives to cut public expenditure such as reducing its allocation of budget onto education & healthcare sector. It is often coupled with higher tax rate. The overall intention is to downsize the government’s fiscal deficit

Evaluations on (A)

(1) Lower life expectancy. This is such an expensive price to pay. While meeting the objective of narrowing down the budget deficit, millions of people are made worse off. When the government reduce the funding onto healthcare sector, there will be lesser numbers of doctors trained, fall in the availability of medicines & drugs, no new hospitals built etc. It is not surprising to hear that life expectancy in most SSA (Sub Saharan African) countries is below 45 years of age. In Zambia, life expectancy has fallen from 50 to 32 years old. In Zimbabwe, maternal & infant mortality rates are increasing, even in capital city like Harare

(2) Lower literacy rate. Reduction in educational spending has translated to problems like erosion in quality of teaching, lousy infrastructures e.g. lack of computers & furniture, curriculum development, no new schools coming up etc. Over the years, existing number of schools is disproportionately matched by the increase in the number of children. This means many underprivileged will be denied a chance even primary education. Therefore, they are unable to write short & simple statements or perform basic arithmetic. The vicious cycle of poverty begins here

(3) Low productivity. Lack of access to basic healthcare & education are the prime cause. People who are sick will definitely have lower output. Also many of the working days might be taken off as sick leave. As for lesser formal education, these people will find great difficulty in operating machineries, solving difficult issues or understanding complex instructions. Their work pace is likely slow

(B) Privatisation of state-owned firms & services. By selling government entities to private sector, more money can be raised to finance its external debt. Also once having profit motive in mind, these newly created private entities will strive to become more cost efficient, innovative & competitive on a global scale

Evaluations of (B)

(1) Exacerbating unemployment. Privatisations of state industries have resulted in mass unemployment as firms now strive to be cost efficient. This actually worsens the situation. While I agree that governments may receive some form of payments from disposing these entities, the lost in the long run is even greater due to loss of potential tax revenue. Also unsettling unemployment, leads to civil unrest, riots & rise in crime rates

(2) Lower life expectancy & literacy rate. Once privatised, hospitals & schools began to impose some fees, although not that high but still unaffordable. Even exemption of fees are given to those very poor, somehow they need to prove their poverty. The process is usually long & cumbersome. Many are therefore discourage to seek treatment & take up education

(3) Private firms exploiting the poor.
With the ultimate aim for profit & considering their own private benefits, some firms in Uganda have increasingly sold those expired drugs to patients. Others include various type of charges being levied for instance unreasonable consultation fees, medical prescription fees etc. These result in lower consumer welfare

(C) Currency devaluation. In theory, the weakening currency of home country should be welcomed as this will increase the demand for exports. It is one of the methods to increase price competitiveness other than privatisation mentioned above. Also farmers will be able to export their farm output in larger scale thus earning more revenue for themselves. As for country itself, increase in export activities enable it to earn more foreign exchange that can be used to pay off its debt. Not to mention, it’s also meant to narrow the deficit in BOP

Evaluations of (C)

(1) Decrease standard of living. Currency devaluation is consistently viewed as the most effective arsenal in reducing BOP deficit, by encouraging exports & discouraging imports. Nevertheless it creates some other problems. For instance, weakening power of home currency may lead to difficulty in purchasing essential goods like food, fuel, capital goods etc. This further deprives the life of those poor people

(2) Opportunity costs in other spending. With limited amount of income, households have to make wise choice. Spending too much on imported essential goods may denied them to other necessities such as healthcare & education

(3) Inflationary effects. Rapid devaluation which leads to ballooning exports can lead to higher inflation in local economy. This will worsen the existing standard of living. Also in future, I’m afraid that locally made goods will lose its appeal in terms of competitiveness. So, will there be another round of devaluation imposed by IMF?

(4) Possible distortion of exports. Agricultural production for exports tends to be heavily reliant on imported inputs, the price of which rises under devaluation. Farming activities such as in SSA countries are small scale & they may not be able purchase these capital goods. Furthermore government is not allowed to provide any subsidies to these farmers. As such, farm output for exports may not be that large as thought

(D) Holding down wages. Salaries are being cut or freeze & minimum wage policy is dismantled. This is applicable for both private & public sector. As for private, the intention is to help firms minimise their production costs which will ultimately be reflected in the pricing of their goods. For public sector, again the intention is to slash government’s current spending so that it can narrow down the budget deficit

Evaluations of (D)

(1) Fall in productivity. Due to labour market deregulations, wages have either been cut or freeze & minimum wage policy was abolished while allowing inflation to escalate at same time. According to ILO report, real wages (adjusted for inflation) in Africa have fallen more than 60% since 1980s. Economically, workers facing falling wages will have lower incentive to work hard

(2) Failed to resolve unemployment. Falling real income have destroyed demand for local goods too. In SSA countries, many women are made unemployed when the demand for their textile falls. These displaced women have been forced into informal sector e.g. prostitution in large numbers to compensate for their own income loss

(3) Exploitation of labours. Firms are reported increasingly taking advantage of labour flexibilisation & deregulation. Many workers are put to work for long hours & abysmally paid low wages which don’t reflect the current cost of living

(E) Trade liberalisation. IMF urged those countries to open up their market, with little to no restriction on imports & exports. Import tariffs are decreased to allow the flooding in of foreign goods. This will automatically force local manufacturers & farmers to be more competitive. Marketing board, an organisation created by many producers primarily to control price & help those farmers to sell their agriculture produce was abolished. Again the intention is eliminate the dependency culture among producers. There was also reform onto agriculture policy where more attention is given to cash crops which are more commercialised rather than food crops

Evaluations of (E)

(1) Income inequality between gender. Transition of food crops to cash crops like tobacco, cocoa, coffee, bean & cotton for export purposes obviously benefit male farmers more than women. Interestingly, it is due to men owning larger plot of land than women. Furthermore, women in SSA countries play a major role as food producer & as such having small land is good enough to be self-sufficient. This obviously leads to widening income equality between gender

(2) Worsening hunger. Production of cash crops is very much dependent on the market price. For instance, if the price of cocoa is high more lands will be allocated to plant cocoa. This is obviously detrimental especially in countries where famine is widespread

(3) Local firms can’t compete. The lowering down of import tariffs allows more cheap goods from outside to flood the local market. Local businesses which are not cost & price competitive are waiting to be perished. For instance, many textile mills in Zimbabwe & Tanzania have shut down as they can’t compete with the cheap Taiwanese imports

(4) Loss of markets for farmers. The abolishment of marketing boards worsens the situation. There is no longer price control or organisation that help small-time farmers to market their goods both locally & abroad. It’s like losing sense of direction as these farmers have no connection with any importers from abroad

General criticism:

(1) Lack of involvement & transparency. IMF should negotiate with recipient countries on the terms & conditions of loans before implementing any changes. Also those countries must be given some flexibility & opportunity to reshape the economic mess. Due to immense pressure, later years through PRSP (Poverty Reduction Strategy Papers) these countries can participate by outlining policies they are going to implement & will be reviewed by IMF

(2) Ill-suited policies. IMF seems to implement standardised policies to all affected countries regardless of their macroeconomic conditions. Most often than not, these policies may be good for one but bad for all


As for me, I understand the strong resistance from developing world particularly Sub Saharan African (SSA) countries. While I couldn’t be more than agree with them on all the grievances these policies have caused, I’m somehow still very supportive of many of those programs outlined, except slashing public expenditure on healthcare & education. There is nothing wrong in fact with those programs, it’s just the implementation!

To me, all those reforms can be made BUT gradually, allowing one after another rather than simultaneously at one go. I would say that something need to be done to increase literacy rates & life expectancy first before the rest

1 comment:

Edward Soo said...

Hello, my first question would be:

If the IMF a 'welfare' organisation or a 'business'? It will claim to be a welfare organisation, with its aims to help the poorer nations, but to a very large extent, it is a 'business' as well. "There is no free lunch in this world" I quote my mother. The very fact that the IMF is 'lending' these nations money and not 'giving' these nations money in itself, makes it a business. Therefore, if it is a business, its intention would be to claim back all the money they lend and hopefully make some kind of profit as well. Thus, to ensure that they at least break even at the end of the day, they introduce these SAPs.

We cannot put the blame solely on the IMF. If they introduce fiscal austerity, their reason is to urge governments to spend wisely, not wastefully. We do not know the actual spending habits of these governments and we make the judgement that the IMF is at fault. We have to know whether these governments are actually spending wisely or not. If they aren't, then the IMF has ever reason to impose this SAP. Vise Versa. The question of, cut down by 'how much?' is also key here. Cutting down too much, is of course ridiculous.

Currency devaluation could be also good, especially when trade liberisation comes together. We have seen how Brazil and Argentina have used this 'open market' concept to tackle their debt crisis and they have been quite successful. The question we should ask about currency devaluation is "how much?". Of course, too low is not good. If it is too low, nobody wants your currency, 'hot money' exits the country, no foreign investors would want to invest in your country. However, if it is low, but not too low, it will induce more exports, lowering the BOP deficit. So the question is, how much lower? The IMF must be reasonable.

I see privatisation as a justified measure. But, if privatisation comes along with deregulation, then it serves no purpose. We learn in unit 4, about RPI-X, RPI+K. After privatisation, the government must at least have some control over these companies. We cannot just let them run wild, especially when they are important utilities, like water and electricity. Privatisation WITH competition is good. But I don't think there is sufficient competition in these LDC markets to be able to push them to be efficient. And we know very well, a monopoly is no good to the people. But, IF the govt could impose some regulations like RPI-X on them, then it is justify-able. Otherwise, it is utterly killing the people of that country.

Trade liberisation has been a very effective tool for many developing nations. For instance, the likes of Singapore and Taiwan have benefited from it greatly. However, we must remember that these SSA countries are very much dependent on agriculture goods, when it comes to exportation. They should have the 'comparative advantage' when it comes to these goods. Nevertheless, the Common Agriculture Policy in the UK and the US, could offset this comparative advantage of theirs. Here is where we expect the World Trade Organisation to come in. The WTO urges countries to liberalise trade, but they have to first make the large nations, remove their unfair policies. Then, only it is reasonable for the LDCs, who are dominated by the agriculture sector, to liberalise their trade. This would instantly kill these indebted countries, allowing foreign companies to conquer their local markets, wiping out the local industry.

Well, sorry for writing so much. When I start, I cannot stop. Hehe. Anyways, I think that the IMF should hire economists to study the structure and climate of these indebted countries, before offering them the 'right' SAPs that would benefit them. There is no right shoe size for every human being, you need to find the right measures before imposing them onto these countries. And imposing them SIMULTANEOUSLY is crazy. For instance, currency devaluation vs fiscal austherity. Lower currency would boost exports. Effects like decrease in std of living, distortion of exports may only be short term, IF the govt is allowed to spend BACK to its people by helping them buy capital goods, build more schools, hospitals, etc. However, with both policies placed at once, it is impossible for the govt to maneuver.

I've got one final question. What would happen, if we take the loan, but DO NOT follow these SAPs? How would the IMF be able to monitor every indebted country to make sure that they follow them anyways?