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Press Release

    The IMF and the World Bank

    05/23/2003

    Before getting into the specifics of the debate over two of the most controversial institutions in modern times, consider this admittedly far-out analogy: the International Monetary Fund (http://www.imf.org) and the World Bank (http://www.worldbank.org) are like two huge financial aid organizations, but instead of doling out financial aid to countries, imagine they dole it out to college students.

    These two huge financial aid organizations give out low-interest loans, just like many student aid programs. And, also like many student aid programs, their loans are conditional, as in one has to maintain a certain grade point average to qualify for continued assistance.

    But say these organizations went further. Say they had one idea of how a student should go about maintaining that high GPA. Say they singled out the poorest, most desperate students for this aid and say they imposed on all of them a one-size-fits-all study regimen: tutoring at 5:30 a.m., followed by a short jog, breakfast of bananas and corn flakes, a demanding schedule of courses during the day; then snack time, a reasonable period for socializing, a sensible dinner, and five hours of study at night, with a 9:30 p.m. bed time. Every weekday. After all, this method has been tested and shown to work for most students. With a financial incentive, it should produce great results among all students who need aid.

    However, after a year of implementing this program, the results are less than 100 percent success. Not all students thrive under the regimen. For instance, not all the students in the program can adapt so quickly to course load. Educated in poor schools, they are not used to the demanding schedule of courses. Some of them, rather than five hours of study at night, need a complement of extracurricular activities in addition to their classroom learning – in other words their learning style is more “hands on.” Others are just not “morning people.”
    Mostly, though, they rebel against being told how to run their own lives. They are given a panacea rather than a set of general guidelines to help them correct whatever problems might have been ailing their studies. Instead of correcting those problems, their frustration with the system leads them to slack off or quit.

    The kicker is that rather than suspending aid, the organizations continue to subsidize these students – in fact, those who fail are subsidized more heavily than those who succeed, who are gradually weaned off aid. In such a situation, which makes more sense: adhere to the strict regimen, only to find that if successful your aid disappears? Or party all semester, fail all your classes and queue up for a bigger, fatter check in the spring? After all, if you never graduate, you never have to pay back the money!

    It would be wrong to say this analogy explains exactly how the IMF and World Bank operate. Keep it in mind, however, throughout the following, drier explanation of why these two organizations are so unpopular not only with leftists (chafing against the strict regimen) but also with those who have a free-market perspective (who scream, “Quit rewarding idiotic behavior!”).

    Many of the most controversial actions taken by the Fund and the Bank are actions taken outside of their original missions as part of the mission creep that often affects large bureaucratic institutions; that is, they are created to solve a problem, but once the problem they are created to solve comes under control, they are forced to come up with additional reasons to exist in order to maintain their funding. Both the IMF and the World Bank, originally created in the aftermath of World War II, have reinvented themselves more times the Madonna; they are currently somewhere between urban cowgirl and grenade-tossing Che Guevara wannabe.

    At the UN Monetary and Financial Conference at Bretton Woods (http://www.ibiblio.org/pha/policy/1944/440722a.html), New Hampshire in 1944, the World Bank, originally named the International Bank for Reconstruction and Development, was tasked with rebuilding the world after the massive devastation of the war. In one of the most amazing displays of bureaucratic adaptability ever, the Bank transformed its mission from the reconstruction of postwar Europe into the creation of “a world without poverty.”

    At the same conference, the IMF was given the task of preventing another worldwide economic catastrophe such as the Great Depression. Although the prevention of economic crises has always been the stated mission of the IMF, it has never exclusively focused on that goal. For instance, in the years after it was created, it was used to prop up a “pegged rate” system of currency exchanges around the world. To use a hypothetical example, the Federal Reserve Bank of America would “peg” the dollar by adjusting the money supply and interest rates in order to artificially stabilize the currency: No matter what was happening in the American economy, the “cost” of a dollar would remain the same. A pegged exchange rate, in other words, is an artificial economic distortion. Under a pegged exchange rate, the dollar is a certain value only because the government subsidizes the currency. In the postwar “Bretton Woods” system, the currencies of Europe were pegged to the U.S. dollar and subsidized through loans from the IMF. This system of pegged currencies caused constant currency overvaluation and collapsed in the early 1970s. The IMF changed its mission and became increasingly involved in lending to developing countries with debt crises.

    At around this time, the World Bank was coming under the guidance of Robert McNamara, who redefined its mission from rebuilding the infrastructure of war-torn nations to the ambitious, laudable (and never-ending) goal of creating “a world without poverty.” At this point, the two institutions’ missions, according to former World Bank Vice President Joseph Stiglitz in Globalization and Its Discontents (http://www.wwnorton.com/catalog/spring03/032439.htm), “became increasingly intertwined.” The IMF, supposed to focus on preventing economic crises, “became a permanent part of life” for the developing nations, which constantly seemed to be having them. And since these countries were also the poorest, the World Bank focused most of its attention on them as well.

    As Cato Institute (http://www.cato.org) scholar Brink Lindsey writes in Against the Dead Hand: The Uncertain Struggle for Global Capitalism (http://www.freetrade.org/pubs/books/ATDH/Dead%20Hand.htm), this was the defining change for these two institutions – they were transformed from temporary global stabilizers and rebuilders into permanent crusaders against poverty and chaos. Today the Fund and the Bank are primarily concerned with lending money to developing nations to help them through debt crises. But the real change at IMF, argues Joseph Stiglitz, came in the early 1980s with the arrival at the Fund of a new wave of economists who believed in using the lending power of the bank to force developing countries into making free-market reforms. Whether the change was in their missions or in their ideology, both Stiglitz and Lindsey would probably agree that the institutions have changed for the worse.

    At this point, recall the system of financial aid for college students. In the example, Stiglitz would be the one saying that the course regimen is too one-size-fits-all, but that it would probably work if, say, the students were allowed to design their own regimen. Lindsey would be saying that the whole idea of doling out an endless supply of money to the worst students, and giving them more money the worse they do, is never going to make them better students.

    Many from the political left who criticize the IMF and the World Bank deride those organizations’ clear preference for free-market policies. But free-market advocates think that whatever policies the organizations prefer are beside the point; their actions per se cause undesirable market distortions that almost always cause more harm than good.

    This apparent discrepancy is caused by the schism between the rhetoric of the Fund and the Bank and what they actually do. When a sovereign nation’s economy is so imperiled that the government faces a default on its debt, the IMF and World Bank provide it with low-interest loans, under the auspices of preventing any global economic crisis that might ripple outward. (This is why developed nations fund the IMF and the World Bank out of their own treasuries: They ostensibly provide protection from the worldwide economic chaos that might ensue if one nation or region were to go under.)

    The loans often come with conditions, called “Structural Adjustment Programs.” This means that in order to get the loan, an imperiled nation’s government must promise to make reforms in its economy to reduce the likelihood of such an economic crisis occurring in the future. The current administration of the Fund and the Bank favor the implementation of free-market policies, such as trade liberalization, as the best solution to a country’s economic woes.

    This is where leftist thinkers come in with their critiques (http://www.ifg.org/analysis/imf/imf.htm). First of all, they point out, most of these imperiled countries, almost all of which are in the developing world, do not have the institutions that developed economies have built over time to properly regulate a market economy. Yet a market economy is forced on these countries as a condition of receiving the loans they need to stave off catastrophe. Often, they say, the result is an even worse combination of wealth disparity, increasing poverty and environmental exploitation. To top it all off, the countries eventually have to pay off the IMF and World Bank loans, when often their economy hasn’t even improved. The left would rather see the Fund and the Bank give out loans with radically different conditions, or none at all. They see the conditionality of the loans as the cause of the widely noted failures – in East Asia, in Russia, in Latin America – of the IMF and World Bank to succeed in their missions of global economic stability and poverty eradication.

    But why then, if the IMF and the World Bank are going around promoting free-market economics, do free-market advocates oppose the IMF and the Bank? The answer is that they don’t oppose the policies these institutions promote, but rather the actions of the institutions themselves – their interference in the global economy. To force one-size-fits-all economic policies to any country, no matter how right those policies might be, is to institute the kind of top-down economic planning that should be anathema to free-market thinkers. Central planners at the Fund and the Bank cannot take into account all of the many subtle effects the policies they promote might have on the countries they de facto control with their loans. Even if all the IMF policy recommendations are correct, countries have no incentive to follow them once the bailout check clears. Loan conditionality is a threat with no teeth, because the IMF has demonstrated that it will continue loaning even to delinquent countries. The only real incentive governments have to reform is given when their economies start to fail; then they must either reform or watch their countries slide further into the abyss. IMF bailouts and loans give countries excuses not to make needed reforms and prolong economic backwardness while building up enormous levels of debt.

    But this is not the only way in which IMF and World Bank interventions usually leave a country worse off than before. By putting together generous bailout packages with the principal purpose of enabling cash-strapped countries to pay off their foreign creditors, these institutions encourage foreign investors to engage in risky lending behavior around the world – a market distortion that causes global instability when the whole purpose of the IMF is to prevent it.

    The repeated failures of the IMF and the World Bank have inspired passionate opposition from 20-30 year-olds, because these failures often have devastating consequences for the world’s poor. But when this generation came looking for answers, it found Bono (http://news.bbc.co.uk/2/hi/entertainment/1799103.stm) rather a thoughtful spokesperson for free trade. It would be a severe understatement to say that the protectionist, anti-trade left has been more successful at tapping into this well of discontent for grassroots support. The free-market movement did not even begin to fight.

    The free-market movement made a good intellectual case against the international financial institutions and suggested a solution to the problem: The United States should refuse to extend to the IMF or the World Bank any more funding for their disastrous interventions; instead, it should remove all barriers to the free exchange of goods and services across its borders, regardless of what policies other countries pursue, as an alternative way to strengthen the global economy.

    But the movement was unable to educate and energize a grassroots army on this issue. Instead, a protest movement powered by the organizational muscle of the large labor unions and radical environmentalists used opposition to the Fund and the Bank to advance a protectionist agenda, calling for the erection of tariff walls and subsidies to impede the flow of goods and services across borders. This movement advocated “democratizing” rather than dismantling the Fund and the Bank – in other words, trying to open the Fund and the Bank to pressure from groups that support protectionism and closed borders rather than free trade. The free-market movement espoused a more internationalist position, but the protectionist left overwhelmingly attracted the most grassroots support.

    But a lack of grassroots support is not the only reason why the free market movement has failed to drive the debate. Another reason is that the business lobbies that drive the formation and passage of free trade agreements, such as the proposed Free Trade Area of the Americas, have no interest in defunding and dismantling the IMF and the World Bank. Rather, most businesses would not mind if these organizations continued to provide a safety net for risky but high-yield investments in recently opened markets. Because deep-pocketed business lobbies drive much of the free-market agenda at the political level, the movement is missing a key ally in Washington. This, in addition to a lack of grassroots support, has all but silenced free-market opposition to the Fund and the Bank, and magnified the left’s position in the debate.

    The battle to reform or dismantle the IMF and the World Bank, from either the left or the right, faces an extraordinarily daunting road. Criticisms of the IMF and the World Bank tend to anger Wall Street, and can be fatal to conservative politicians. Wall Street was rocked when former Treasury Secretary Paul O’Neill suggested that most of the money from an IMF bailout to Brazil in 2002 might wind up in “Swiss bank accounts” and thus opposed the move. This and other candid statements (http://www.guardian.co.uk/business/story/0,3604,855579,00.html) contributed to the Bush Administration’s decision to axe O’Neill shortly after the 2002 elections. The movement on the left also faces significant political obstacles, as its inability to project a coherent message (http://www.abolishthebank.org/points.shtml) and the strange tactics (http://www.eddie.com/liveframe/index.cgi/dc-imf/7) of its most vocal adherents (http://cybertraveler.org/a16/a16_pix7.jpg) have relegated it to the margins of American political debate.
    With friends like these, The IMF and World Bank scholarship programs for underachieving countries look safe for the near term. But the problems they pose to the world economy are real, and must be addressed at some point by a consensus of opponents. While this consensus might contain strange bedfellows at first, unlikely alliances can sometimes demonstrate the seriousness of a problem. Perhaps such an alliance is needed to help the developing world graduate to developed economies.

    Suggested Readings:

    Bastiat, Frederic. Economic Sophisms. Irvington-on-Hudson: Foundation for Economic
    Education, 1996.

    Friedman, Thomas L. The Lexus and the Olive Tree: Understanding Globalization. New
    York: Anchor Books, 2000.

    Hazlitt, Henry. Economics in One Lesson. San Francisco: Fox & Wilkes, 1996.

    International Financial Institution Advisory Commission (Meltzer Commission). “Report
    to the U.S. Congress and the U.S. Department of the Treasury.” March 8, 2000. http://www.house.gov/jec/imf/meltzer.htm

    Lindsey, Brink. Against the Dead Hand: The Uncertain Struggle for Global Capitalism.
    New York: John Wiley & Sons, 2002.

    Shultz, George, William Simon and Walter Wriston. “Who Needs the IMF?” Wall Street
    Journal, February 3, 1998.

    Smith, Adam. The Wealth of Nations. Modern Library Edition. New York: Random
    House, 1937.

    Stiglitz, Joseph E. Globalization and Its Discontents. New York: W.W. Norton & Co.,
    2002.