Lender of Last Resort: Rethinking IMF Conditionality
Garuda, Gopal, Harvard International Review
GOPAL GARUDA, Staff Writer, Harvard International Review
On December 1, 1997, the International Monetary Fund's (IMF) Managing Director, Michael Camdessus, announced a historic multibillion dollar bailout of the Republic of Korea. Designed to stabilize Korea's currency (the won) and hasten the nation's recovery following the Asian currency crisis, the Korean stabilization package was expected to require US$20 to 50 billion, by far the largest loan package in the Fund's history. Other large bailouts in recent years exceeded the billion dollar mark, such as Mexico in 1994 and Indonesia in 1997, only to be surpassed dramatically in both size and visibility by the Korean package. These recent Fund initiatives, particularly the IMF's high-profile involvement in Korea, have highlighted the organization's increasing prominence in international finance.
Not surprisingly, the Fund's heightened visibility has led to greater scrutiny of its operations. One of the most controversial issues facing the IMF focuses on conditionality -- the Fund's practice of mandating a program of economic reform as a condition for receiving loans. Fund lending has increased greatly since the Latin American debt crisis of the late 1970s, making these conditionality provisions extremely important. Although direct Fund disbursements make up less than one percent of total capital flows to developing nations, a Fund package tends to serve as a "seal of approval" of a country's economic practices, restoring confidence to foreign investors and multinational banks and thereby encouraging the flow of foreign investment. The increasing size and integration of global capital markets has thus made the conditions attached to IMF loans an important issue in policy discussions.
The Conditionality Debate
The IMF's most persistent critics argue that the Fund's medicine often has bitter side effects. According to these individuals, the IMF's focus on creating a stable macroeconomic climate comes at the expense of long-term growth and creates high levels of unemployment. Other critics claim that Fund programs hurt the poor. Noting that conditionality provisions typically include cuts in government spending, some observers argue that important social programs are sometimes vulnerable targets. These include food subsidies and welfare programs that assist children, the elderly, and other impoverished groups.
When pressed on this issue, the Fund responds that its central mandate is to help member countries pursue sound macroeconomic policies that should lead to sustainable economic growth. Improved growth, in turn, should have important beneficial implications for the poor -- and everyone else. The IMF also points out that it does not dictate the specific details of reform programs, such as specifying the exact source of budget cuts. Furthermore, the Fund argues that the links between Fund-supported adjustment programs and poverty are more complex than its critics realize. The elimination of price ceilings on foodstuffs can worsen poverty by increasing the cost of comestibles; however, such practices might actually help the poor by increasing the incomes of rural farmers. This is particularly true in many developing countries where rural farmers make up a large fraction of the poor. Harvard agricultural economist Peter Timmer has shown that the welfare gains from removing price ceilings on food products may be surprisingly high. In addition, promoting agriculture often has important "spinoff" benefits including the development of rural credit markets and increased food security.
The debate over conditionality is particularly polemic because it is often perceived as a struggle between developed and developing nations. In the two decades following World War II, both rich and poor countries were potential users of the Fund. In the 1960s the United States considered drawing on its Fund resources, and both the United Kingdom and Italy concluded major standby agreements in the 1970s. …