http://www.forbes.com/forbesglobal/99/1004/0219081a.htm
FORBES GLOBAL October 04, 1999
The International Monetary Fund and the World Bank start their annual meetings in Washington on Sept. 21. Not on the agenda (but on many policymakers' and analysts' minds) is a question that won't go away: Have these institutions outlived their usefulness? Forbes Global asked columnists Domingo F. Cavallo and Steve H. Hanke to explain what future, if any, they see for the fund and the bank.
Reform them
By Domingo F. Cavallo
Don't abolish the IMF and the World Bank. They can play useful roles in fostering development and helping countries cope with international financial crises. But I do think that they are in great need of improvement.
It is remarkable how rarely things have turned out well when the IMF has become deeply involved in a country. The same could be said of the World Bank. But the fact that both institutions have messed things up so often means that they must be made more attuned to the needs of today.
There are several ways in which IMF or World Bank policies have gone wrong in the past. For one thing, these institutions should not be substitutes for local leadership or ideas. They should complement them. Too often, when the locals lack ideas about how to face the challenges ahead, the IMF and World Bank volunteer their own. Furthermore, they make these ideas part of the conditions for lending.
Countries resent the advice, and the political establishment moves against the IMF and the Bank. Sooner or later, the policies are abandoned. Worse still, if the countries do not believe in the conditions attached to the loans, they do not wholeheartedly embrace them. Half-baked policies pursued only because those abroad demand them are a sure recipe for disaster. Such IMF mistakes only make it more difficult to implement sensible programs in the future.
At the opposite extreme, there are countries with carefully thought-out ideas that do not receive IMF or World Bank support and end up doing well. Chile in the 1980s is one example; cut off from international support because of its dictatorial regime, it embarked upon an economic program that produced miracles.
The IMF cannot substitute for home-grown ideas, nor should it impose programs on a country. It should support a country's policies only when it considers those policies to be right. Since international financial markets don't work perfectly under all circumstances, support should be in the form of money. The fund and the bank should play more of a consultative role, as a sort of databank of ideas and policies. They should use the resources at hand to support those programs that draw intensively on good ideas.
I can also think of another role for the two institutions. I envisage the IMF operating as an insurance agency in the form of a club. The size of membership dues would be determined according to a country's economic performance as judged by a set of indicators. Countries that deviate the furthest from the objectives pay higher dues, just as people under 25 years of age pay higher auto insurance rates.
When a country suffers a negative shock, the amount of assistance from the Fund and the Bank would be determined by a set of previously established factors.
It is remarkable how rarely things have turned out well when the IMF has become deeply involved in a country.
It's important also to ensure that the indicators are completely transparent and continually updated. Clearly, if a policy like this had already been implemented, Russia would never have qualified for the loans it has squandered. At the same time, such a scheme would help to isolate the fund from the sort of political pressures that led to the funding for Russia.
The World Bank should focus on helping countries where capital market failure is more prevalent. The Bank's top priority should be to help with poverty alleviation, environmental programs and human capital development.
The next priority should be to assist countries undertaking complex reforms. When a near-bankrupt government such as Ecuador decides to launch a massive public sector reform with thousands of workers having to be laid off and retrained, the World Bank could provide financing if the private capital markets are too skittish to step in. Where I fail to see a role for the Bank is in the financing of roads and hydroelectric dams or the financing of budget deficits.
There's another question that needs answering, and that's the role of the fund and the bank in propping up corrupt dictatorships. How much of the money lent by these institutions ended up in the hands of corrupt officials or local mafia bosses? Under the new roles I propose for the two organizations, undemocratic governments would automatically be excluded from membership, and all funding would be cut off at the first sign that the money from the fund and the bank was being used corruptly. The simple application of these rules would have eliminated the Suhartos of this world.
This analysis raises the question: Would the world be better off if the World Bank and the IMF were eliminated? I suggest that a thorough reengineering of them would be even better. It is not too late for them to mend their ways, once and for all. The time of reckoning is at hand.
Domingo F. Cavallo is the former economics minister of Argentina and a candidate for his country's presidency.
Enough is enough
By Steve H. Hanke
The Thai baht collapsed on July 2, 1997, and other currencies in the region fell like dominoes shortly afterwards. The IMF cavalry came riding to the rescue with bailout money and big reform packages. Most of the IMF's reforms were of the microeconomic variety and were ill-suited to remedy the life-threatening currency crises that engulfed the region. What is more, the IMF's standard macroeconomic medicine--fiscal austerity--acted like a wrecking ball on economies that were already operating under prudent fiscal regimes.
The inappropriateness of the IMF's prescription was nowhere more evident than in Indonesia. The rupiah's exchange rate against the dollar had actually been quite stable until Aug. 17, 1997, when Indonesia floated its currency. On that day, the IMF lavished praise on the Indonesian government. Indeed, Stanley Fischer, the IMF's managing director, went so far as to proclaim that the floating rupiah "will allow [Indonesia's] economy to continue its impressive economic performance of the last several years." This turned out to be the first of many IMF pronouncements that would fail to pass the test of time.
By late October 1997, the rupiah was not floating on a sea of tranquility, and the Indonesians called in the IMF for more advice. Indonesia was facing a potential currency crisis, but the IMF insisted that it do something about rampant cronyism. This, despite the fact that for years it turned a blind eye to the World Bank's practice of pumping money into corrupt Indonesian schemes. On Nov. 1, the IMF assisted in the closure of 16 crony banks. This set off a financial panic. Money was pulled out of all the Indonesian banks and took flight to Singapore. The rupiah and the foreign reserves of the Bank of Indonesia fell further.
In an attempt to stem the tide, President Suharto signed a second IMF letter of intent with Michel Camdessus, the fund's managing director, glowering in the background. Before the ink had dried, the markets were pounding the rupiah once again. Indeed, the rupiah dropped 10% on Jan. 15, 1998, the day the agreement was signed, and continued to plunge during the following week. The rupiah ended up 85% lower against the dollar.
Why did the markets deliver such a resounding vote of no confidence? The second IMF agreement was little more than a large-scale structural adjustment program aimed at rooting out cronyism and opening the economy. It failed to address Indonesia's main problem, a collapsing currency. The second IMF program, like the first, did nothing more than pour fuel on a raging fire.
To put all this into perspective, assume that the U.S. dollar was collapsing and the IMF offered the U.S. financial assistance, an assistance package that contained two conditions. To save the bankrupt social security system, the U.S. would have to privatize the system in six months. And to clean up its balance sheet, the U.S. federal government, in the same six-month period, would have to privatize its landholdings, comprising one third of the area of the U.S. While both of these privatizations policies would be desirable, their implementation in six months would be politically impossible. Never mind.
The magnitude of what the IMF mandated that Suharto deliver was roughly the same as the hypothetical notion presented above. And to add insult to injury, the IMF's Indonesian package failed to address Indonesia's immediate problem, the collapse of the rupiah.
For a second opinion, Suharto called me in as his advisor in February, when the idea of a currency board was first broached. The rupiah rose 28% on the day people first heard about my currency proposal, infuriating both the IMF and the U.S. government. They threatened to withhold bailout money unless Indonesia dropped the idea immediately. Caving in to this threat, Suharto abandoned the currency board idea in March.
On Apr. 10, 1998, a third IMF agreement was signed. It still failed to address the Indonesian currency crisis, and still more microeconomic reforms were mandated. The fuel price increases of May 4 were too much for the Indonesians to bear. Bloody riots ensued, and Suharto finally packed his bags after 32 years. It was all too predictable and makes one wonder whether Suharto's departure was the real aim of the IMF.
But with the IMF programs still in place, that sad tale didn't end with the fall of Suharto. Blood is still flowing in parts of Indonesia, and the rupiah is falling once again.
The IMF doomed Indonesia by focusing exclusively on cronyism and corruption. Ironically, it lost Russia by turning a blind eye to these same maladies. It's time to pull the plug on the all-knowing bureaucrats in Washington. Enough is enough.
Steve H. Hanke is a professor of Applied Economics at The Johns Hopkins University in Baltimore.
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