Six Key Lessons The IMF Ignored In The Euro Crisis
Ngaire Woods
Over
the last few decades, the International Monetary Fund has learned six
important lessons about how to manage government debt crises. In its
response to the crisis in Greece, however, each of these lessons has
been ignored.
The
Fund’s participation in the effort to rescue the eurozone may have
raised its profile and gained it favor in Europe. But its failure, and
the failure of its European shareholders, to adhere to its own best
practices may eventually prove to have been a fatal misstep.
One
key lesson ignored in the Greece debacle is that when a bailout becomes
necessary, it should be done once and definitively. The IMF learned
this in 1997, when an inadequate bailout of South Korea forced
a second round of negotiations. In Greece, the problem is even worse,
as the €86 billion ($94 billion) plan now under discussion follows a
€110 billion bailout in 2010 and a €130 billion rescue in 2012.
The
IMF is, on its own, highly constrained. Its loans are limited to a
multiple of a country’s contributions to its capital, and by this
measure its loans to Greece are higher than any in its history. Eurozone
governments, however, face no such constraints, and were thus free to
put in place a program that would have been sustainable.
Another
lesson that was ignored is not to bail out the banks. The IMF learned
this the hard way in the 1980s, when it transferred bad bank loans to
Latin American governments onto its own books and those of other
governments. In Greece, bad loans issued by French and German banks were
moved onto the public books, transferring the exposure not only to
European taxpayers, but to the entire membership of the IMF.
The
third lesson that the IMF was unable to apply in Greece is that
austerity often leads to a vicious cycle, as spending cuts cause the
economy to contract far more than it would have otherwise. Because the
IMF lends money on a short-term basis, there was an incentive to ignore
the effects of austerity in order to arrive at growth projections that
imply an ability to repay. Meanwhile, the other eurozone members,
seeking to justify less financing, also found it convenient to overlook
the calamitous impact of austerity.
Fourth,
the IMF has learned that reforms are most likely to be implemented when
they are few in number and carefully focused. When a country requires
assistance, it is tempting for lenders to insist on a long list of
reforms. But a crisis-wracked government will struggle to manage
multiple demands.
In
Greece, the IMF, together with its European partners, required the
government not just to cut expenditures, but to undertake far-reaching
tax, pension, judicial, and labor-market reforms. And, although the most
urgently needed measures will not have an immediate effect on Greece’s
finances, the IMF has little choice but to emphasize the short-term
spending cuts that boost the chances of being repaid – even when that
makes longer-term reforms more difficult to enact.
A
fifth lesson is that reforms are unlikely to succeed unless the
government is committed to seeing them through. Conditions perceived to
be imposed from abroad will almost certainly fail. In the case of
Greece, domestic political considerations caused European governments to
make a show of holding the government’s feet to the fire. The IMF, too,
sought to demonstrate that it was being as tough with Greece as it has
been on Brazil, Indonesia, and Zambia – even if doing so was ultimately
counterproductive.
The
sixth lesson the IMF has swept aside is that bailing out countries that
do not fully control their currencies carries additional risks. As the
Fund learned in Argentina and West Africa, such countries lack one of
the easiest ways to adjust to a debt crisis: devaluation.
Having
failed to forewarn Greece, Portugal, Ireland, and Spain about the
perils of joining a currency bloc, the IMF should have considered
whether it was proper or necessary for it to intervene at all in the
eurozone crisis. Its rationale for doing so highlights the risks
associated with its decision.
The
most obvious reason for the IMF’s actions is that Europe was failing to
address its own problems, and had the power and influence to drag in
the Fund. The IMF’s managing director has always been a European, and
European countries enjoy a disproportionate share of the votes on the
IMF’s board.
Equally
important, however, is the fact that the IMF made its decision while
facing an existential crisis. Historically, the biggest threat to the
IMF has been irrelevance. It was almost made redundant in the 1970s,
when the US floated the dollar, only to be saved in 1982 by the Mexican
debt crisis, which propelled it into the role of global financial
lifeguard.
A
decade later, the IMF’s relevance had started to wane again, but was
revived by its role in the transformation of the former Soviet-bloc
economies. At the time of the euro crisis, the Fund was floundering once
more in the aftermath of the East Asian crisis, as its fee-paying
clients did anything they could to avoid turning to it.
The
IMF’s participation in the eurozone crisis has now given powerful
emerging economies another reason to be disenchanted. After the US stymied their demands for
a greater say within the Fund, they now find that the organization has
been doing Europe’s bidding. It will be difficult for the IMF to regain
the trust of these increasingly prominent members. Unless the US and the
EU relinquish their grip, the Fund’s latest bid for relevance may well
turn out to be its last.
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