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close this bookCERES No. 106 - July - August 1985 (FAO Ceres, 1985, 50 p.)
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The Prescription Of Austerity: an Examination of the IMF Role

by Jean David Avenel-Zylbermann

Ever since the International Monetary Fund opened operations on 22 March 1947, its member countries have been assured of aid in terms of foreign currency, for which they discount their own national currencies. Foreign currency can be obtained through the procedure of drawing rights within the framework of the new IMF general account. In recent years it has become normal practice for developing countries to exercise their drawing rights. But these rights entail adherence to the Fund's recommendations on economic policy. Lately, however, as the result of events in countries like Brazil, Morocco, and Tunisia, the validity of these recommendations has been questioned, and in many cases the IMF has been held responsible for the austerity crisis prevailing in these countries.

The object of this article is to see whether such criticisms can be substantiated or whether it would not be wiser to look within the assisted countries to account for the hard times they now face.

First and foremost. IMF is a monetary institution with limited resources. Its prime objective is to promote the smooth expansion and growth of international trade. By so doing it helps to achieve objectives in employment, income, and economic development. IMF; was not created to assist developing countries, as the World Bank was. This distinction is fundamental because many of the criticisms launched against the Fund assume that its role is much the same as that of the World Bank. IMF, however, has neither the mandate nor the means to grant aid for development.

The renewable credit principle. According to its by-laws, loans must be paid back within a period of five years to allow the Fund to recover the means to assist other countries. As a result, deficits in the balance of payments, which need to be made up if employment and income targets are to be met, must be temporary. This explains why the financing procedure is geared to a set of economic measures aimed at restoring equilibrium in the country's balance of payments. This celebrated principle of conditionally has become the favorite target for attacks on the IMF. Conditionality is part of the Fund's mechanisms, and it is assumed that member countries have accepted it when they agree to observe the Fund's by-laws. Moreover, it applies to all countries eligible for aid at the point where they are entitled to their second installment of credit. (Over and above a so-called reserve instalment, IMF grants four credit instalments, each equal to 25 per cent of the member country's portion. Access to the reserve and to the first credit instalment is entirely free from any IMF constraint upon the policy of the borrower country.) By definition these loans are granted for a one-year period, but they may also be extended up to three years as long as it is understood that the conditionality principle may be applied. Any criticisms of the Fund should be reconsidered in the light of this mechanism. Acceptance of this point implies that the IMF cannot be expected to shoulder all responsibility for the period of austerity these assisted countries are passing through, since they are committed to these-conditions from the start. At this stage it may be as well to examine to what extent the more specific criticisms of the Fund are justified.

"A package of standardized measures." One of the most frequently voiced criticisms levelled at IMF is that it recommends the sort of policies that serve the interests of the United States. It is true that the IMF's interpretation of the economic and financial crisis of Third World countries does seem to keep more or less in step with that of the American Government's, and that the Fund's policy has many points in common with views of "supply side" economists. The primary aim of this policy is to assist countries in balancing their foreign payments, since it is impossible to work out a lasting positive rate of growth when budgeting and foreign payments are thrown violently out of balance. Somehow or other growth must be restored by stabilization

The result of this analysis is the package of standardized measures'', as they are called by certain writers. These are the measures countries are bound to apply in exchange for aid: strict control of the public deficit by reduction of public expenditure, abolition of subsidies on certain food products, an increase in taxation and tariffs for public enterprises, a tighter rein on the volume of money by rationing credit, raising the rate of interest, and adjusting the rate of exchange by devaluation. The meaures may be strict, but they leave local governments with reasonable room to manoeuvre, as we shall see later. The result, according to some IMF critics, is the austerity/privatization/unity of price triangle.

lt may well be wondered whether IMF economic policy, as outlined above, is in fact responsible for austerity in assisted countries. As a rule these countries have left it too long before turning to the IMF to help them out. Errors on the part of local administration (overindulgence in prestige investment, superfluous military expenditure, corruption, etc.) have already done most of the damage and the economic growth rate has fallen accordingly. Empirical studies show that whenever the IMF intervenes, the volume of the medium-term growth rate begins to rise, since financing from the Fund will maintain the total value of imports and allow the pace of activity to continue undisturbed. At the same time these adjustments, while favoring restructuring in the viable sectors, can often cause losses in non-incomensuring sectors of the economy.

But conditionality is usually a bitter pill to swallow, and so the IMF has been reproached for suspending loans to countries that have failed to respect the policy it recommended. This happened in 1982 with Madagascar, Uganda, Senegal, Tanzania, Togo, Zaire, and Zambia. Though such a decision may appear severe, one is bound to admit that economic recovery cannot be based upon the policies that caused the recession in the first place. There were policies that maintained budget deficits, artificially high exchange rates (seriously affecting incomes from exports and causing a loss in confidence in the value of money among the nationals); negative real rates of interest (causing misuse of savings and maladministration of foreign debts) as well as the creation of money. It was only logical to modify inappropriate policies that had ceased to function. Also, in the context of the trends of the 1980s. Keynesian-inspired policies offer no solution for the present economic crises in many countries, as quite a number of developed countries are finding out for themselves.

A concerted policy. IMF has also been charged with imposing its policy upon national governments without coming to any agreement with them. In actual fact, there has been real collaboration between national authorities and the Fund, and this occurs at a variety of levels.

In the first place, the Fund collaborates with national authorities from the moment when its intervention is required, and the causes and nature of the economic problem afflicting the country are jointly identified. Next, representatives of the states concerned collaborate with those of the IMF to work out possible economic options within the framework of the institutional structure of the country in order to ensure equilibrium between available total resources and demand. Third, the authorities hold discussions to define the most effective set of measures to be applied. Finally, the IMF and the assisted countries remain in contact and, from time to time, examine the results of the measures adopted. These periodic contacts are a means of assuring that the Fund's interventions remain flexible. They leave ample room for a readjustment of the measures if needs be. This is the way the Fund is intended to work, and, despite often-expressed opinions to the contrary, it would seem essentially pragmatic. Furthermore this continuity in the Fund-countries relationship is in con formity with the by-law stating that member countries are bound to collaborate at all times with the IMF. It is part of the Fund's special procedure, thanks to its consultations with the countries, often on a multilateral basis. Such supervision results in an analysis of interactions between national policies.

On the other hand though IMF charts out the main points of economic policies in collaboration with the national authorities, it is the authorities who, in the last resort, are obliged to settle the details and concrete execution of these policies. They decide the distribution of credit, the areas in which public expenditure will be curtailed, and the application of taxes and subsidies. To mention a few concrete examples: it is the national financial authorities who decide how the burden will be distributed, by the various socio-economic categories (e.g., overall reduction of salaries, taxation) or the distribution of reductions on subsidies for imported products (e.g., primary needs or luxury products). The real impact of the policy governing distribution of income, employment, and the quality of social services will consequently depend upon the way in which it is applied, and, in the final analysis, upon the local authorities. So it would not seem that the country loses any prerogative over the period of adjustmentat least not at this level.

In actual fact, the outcome of the stabilization plan depends upon the degree to which the country concerned is committed. The programme may come to grief if national negotiators are not prepared to act in good faith, if they do not have the backing of their government, or if they do not always come up with the proper information once the decision is taken. This occurred in Peru in 1981. The bad faith on the part of the negotiators toward the IMF and an inadequate system of information (which meant that by the time the real problems of public finance were discovered it was too late) led to a clash over adjustment policies.

Total commitment to the Fund's policy alone on the part of the country is not, however, in itself sufficient for successful stabilization. The interaction of international and national conditions may also cause a temporary hold-up for the adopted measures. This happened in Zambia when the price of copper weakened. The point is that in all these cases a breakdown in agreement should not be laid at IMF's door.

A flexible and timely approach. IMF has also been reproached for proposing measures without showing much interest in the individual countries themselves, or taking case by case. We have already seen what kind of measures these are and noted that the main points of the Fund's policy have remained constant: liberalization of the economy, improvement in the situation of public enterprises, reduction of public expenditure, and/or an increase in taxation, since the part of reimbursement of interest in public expense rises in proportion to CDP. Actually this resemblance is only superficial. A detailed analysis of the concrete measures adopted, however, shows that IMF does not work with a rigidly uniform model of approach, in spite of the importance given to credit and foreign debts, financing the public sector, rates of exchanges and interest, and prices of basic products. Here, the policies are very general, and the ways in which they find concrete application are many and varied.

IMF's cooperation strategy is pragmatic. It consists of a clear statement of finance for programmes of economic recovery, and since situations vary from one country to another, each case is treated individually. It would be inconceivable, of course, to apply the same measures to both Mexico, with its immense natural resources, and an African country on the verge of destitution.

The Fund's flexibility in regard to each situation derives from the principle of conditionality, and its mode of functioning varies from country to country. In each case IMF reexamines the budgets, takes account of the cost of energy for the countries with no energy resources of their own, analyzes the programme according to the cost-efficiency duo, which again differs from country to country, proposes a well-balanced distribution of burdens in the form of temporary taxes or cutting back certain public expenditures. Moreover, the fact that a concrete application of these proposals is, in the end, the job of the government implies respect for the particular character of each country.

The final important criticism we shall deal with concerns the amount of aid granted by the IMF, which has often been considered less than sufficient and has been identified as yet another contributor to austerity. The Fund is constantly having to face this problem. In 1983/84 withdrawals rose by 70 per cent and net purchase by 80 per cent, whereas reimbursements amounted to no more than two billion SDR. This sum however was higher than that of the financial year 1982/83, so it looks as though the downward trend in reimbursements has now been reversed. Should this up-trend be confirmed, new capital could be released. It should be noted, too, that IMF's objective is to maintain its policy of broadened access. This, of course, implies a strengthening of international cooperation and further efforts on the part of the industrialized countries in their financial contributions to IMF. But it also implies a responsible attitude on the part of assisted countries, and their willingness to appeal to the Fund and adopt corrective measures immediately when their problems first appear, in order to keep aid requirements to a minimum.

Finally, it is worth considering another element in analyzing the amount of aid granted by the Fund. This is a secondary effect arising from the adjustment programme, which allows for the recovery of the developing country's foreign credit and the release of additional funds from commercial banks and public creditors. It has been calculated that every single dollar the Fund has loaned to Brazil and Mexico has eventually released seven dollars in the form of new loans. One of the essential elements of IMF's action is reviving confidence in the assisted country. If the current deficit can be financed by the entrance of foreign capital, provided the amounts and conditions are acceptable, then the situation of the country can once again be considered viable.

This was the case with Brazil. Its financial re-establishment in 1984 involved 4.4 billion SDR, which have since produced $6.5 billion of loans from commercial banks, $2.5 billion from public commercial credits, as well as a revision of foreign debts amounting to $3.5 billion. In this case we cannot see how IMF could possibly be wholly responsible for the austerity period which so many Third World countries are experiencing at the moment. There may be no doubt about the rigour o the economic policy recommended by the Fund, but the national governments do possess a significant margin of manipulation as far as the mode of application is concerned. They participate in working out the policies to be adopted and are alone responsible for the concrete and de tailed application of the measures out lined and adopted with IMF. There is far too great a tendency to regard IMF as a scapegoat and make responsible for a situation usually created by bad administration and certain personalities therein. The role of the Fund must therefore be restored to its real province. There should be worldwide agreement the policies it proposes, within specific time periods, lead to the economic recovery of member countries, and this seems to be the case with severe countries in Latin America.