Problems with the IMF

There are myriad problems--both institutionally and theoretically--with the IMF.

1. IMF bailouts are more likely to cause financial crises than prevent or cure them. Congress should attend to the powerful yet indirect influence the IMF exerts in promoting financial and economic crises. The IMF's record of "rescuing" troubled economies invites governments to follow imprudent economic and monetary policies, since the political and economic costs of failure are reduced by the promise of a bailout.

Why? Just the possibility of an IMF rescue creates what economists refer to as a "moral hazard." Bailouts shield investors and politicians from the consequences of their poor decisions by "socializing" risks and reducing the cost of failure associated with an investment. Risks are socialized because everyone ends up paying for individual investors' errors. The costs of failure are reduced because, directly or indirectly, the IMF compensates investors when their investment plans fail. In other words, IMF bailouts encourage speculation of the sort that investors probably would avoid if the IMF were not there to shield them from failure. Bailouts send signals to governments that they will not have to bear the costs of failing to reform their economies: The IMF will be there to pay the price of their inaction. Thus, the IMF's actions will neither prevent nor cure financial crises--they will encourage them.

Indeed, evidence seems to indicate that IMF advice precipitated the very same Asian crisis that Treasury and IMF officials are invoking to strong-arm Congress into appropriating this additional $18 billion. According to The Wall Street Journal, "The IMF tripped this crisis by urging the Thais to devalue [the baht], then promoted contagion by urging everyone else to do likewise.... [P]utting more money into today's IMF is not likely to solve any crisis. It is more likely to cause new ones."¹² Clearly, providing more gasoline--in the form of additional resources--for the IMF to start financial fires around the globe is not the way to promote economic stability.

Financial hardship and defaults occur every day in the U.S. economy. They are a necessary and natural reflection of free markets. Bankruptcy is the market's method of reallocating capital to more productive uses, or away from managers who failed to create wealth for investors or improve the well-being of consumers. As assets are purchased at a reduced rate by the highest bidder, both parties to an ill-considered lending or investment decision suffer a loss; but the overall economy profits because new, presumably better managers will now control the capital. In the international market, however, the IMF distorts this mechanism by rewarding inept managers with financial assistance.

Without the IMF, borrowers and creditors would be forced to resolve the situation in the Asian countries by renegotiating loans or seizing assets. A world without the IMF would have to observe the greater discipline of market forces. Banks and investors would be more cautious in assessing risk before investing or committing loans. Countries wishing to receive foreign loans and investment would have to adopt transparent economic policies that lower risk for lenders and investors. Specifically, they would have to create fair and reliable bankruptcy laws, employ transparent and internationally accepted accounting procedures, allow minimal government interference in the allocation of credit, exercise prudent oversight of their banking systems, and encourage rather than prevent domestic and foreign banking competition.

2. The IMF lacks transparency. I congratulate the members of the committee for requiring truth in testimony, a policy The Heritage Foundation has long supported. This provision of the House rules was designed to ensure that Congress has access to all information on those who testify before its committees. This allows you to determine whether the information a witness presents has been biased or unduly influenced by the witness's supporters. Firmly embedding this transparency in the legislative process is vital.

Prompt, unbiased (or, at least, admittedly biased) information is just as important for international organizations such as the International Monetary Fund to perform their assigned duties. Indeed, Article VIII of the IMF Articles of Agreement, the "General Obligations of Members," specifically states that each member is required to provide information "as [the IMF] deems necessary for its activities, including, as the minimum necessary for the effective discharge of the Fund's duties."¹³

Yet, even though the IMF recognizes the necessity of timely, unbiased information to its successful operation, it fails to acknowledge the necessity of giving such information on its own organization and operation to its member governments and their citizens.

It is imperative that the IMF be forthright in providing information necessary to enable its member governments and the public at large to make informed decisions about the performance, record, and necessity of the Fund.¹⁴

Far from encouraging public inspection, however, the IMF refuses to release the vast majority of its information on economic policies, past performance, and internal meetings to the press or the interested public. In fact, the culture of secrecy is so inculcated in the IMF that it actively discourages and often prohibits public access even to public records. Anyone not employed by the IMF must apply for an appointment to gain access to its library, which is open only on Tuesdays and Thursdays. It can take up to six weeks for the IMF to process the application--and approval is by no means certain. Students are not allowed in the library at all.

Although this lack of public transparency is very disturbing, the Fund's refusal to grant congressional offices free access to its records is totally unacceptable. As described by Representative Jim Saxton of New Jersey, Chairman of the Joint Economic Committee, the IMF will withhold any information it wishes from its member governments--and the U.S. Congress, which may wish to conduct an informed debate on the organization--while simultaneously demanding that those governments contribute billions of dollars to its coffers.

The U.S. Department of the Treasury, which oversees membership in the IMF through the U.S. Executive Director of the IMF, seemingly is a willing co-conspirator in this culture of secrecy and exacerbates this lack of transparency. Indeed, the Treasury Department offered Chairman Saxton a copy of IMF documents only on the condition that he keep the documents and their contents confidential and hidden from public scrutiny.¹⁵ This incident, following the IMF's historical pattern, led the Joint Economic Committee to conclude that:

Both IMF and U.S. Treasury bailout policies remain overly secretive, ambiguous, and ill-defined. Because these policies are seldom explained to the public, unnecessary misunderstanding, resentment, and opposition often result. A good deal more transparency is called for from both of these taxpayer-financed institutions. Explicit specification of the IMF's objectives, for example, should be accompanied by clarification of the procedures and practices by which it accomplishes these objectives. At a minimum, full explanations of the conditions, lending terms, subsidies involved, and the rationale as to why such lending is necessary are essential. Additionally, those entities actually receiving taxpayer subsidies should be identified.¹⁶

This sentiment is echoed by Jack Kemp, who stated in a recent letter to Representative Armey, "I urge you to put off a vote in the House on any additional funding for the IMF at least until that organization complies with all outstanding congressional information requests."¹⁷

3. IMF loans provide massive subsidies to borrowing countries. The IMF has a number of different facilities for extending financial assistance to its member countries. They range from the extremely short-term Stand-by Arrangements, which are typically extended over 12 to 18 months and repaid within five years, to long-term assistance, such as the Enhanced Structural Adjustment Facility (ESAF), which is repaid over ten years and includes a five-year grace period. All IMF assistance is extended at conditional, or below-market, rates. The Stand-by Arrangements are charged a slightly below-market rate of 4.5 percent; the ESAF loans are nearly free, with an annual interest rate of only one-half of 1 percent (0.5 percent).¹⁸ Even the most creditworthy nations cannot receive such interest rates on the private financial markets; the United States must pay around 5.5 percent on government bonds of similar maturity.

The highly subsidized interest rates on IMF bailouts and structural adjustment loans are equivalent to a massive transfer of wealth from American taxpayers and other countries. For example, the IMF extended most of its loans to Indonesia, South Korea, and Thailand at subsidized rates (between 4.5 percent and 4.7 percent). These same countries were required to pay approximately 14.5 percent on comparable government bonds to access credit in the private sector. David Sachs of the Independent Institute and Peter Thiel of Thiel Capital International LLC estimate that because of IMF subsidies, "Over three years, South Korea, Thailand, and Indonesia will have received a direct wealth transfer of at least $35 billion, mostly from U.S. and Western European taxpayers."¹⁹

Interest rates usually are determined by the borrower's risk and creditworthiness. The IMF ignores these factors. In fact, it actually rewards high-risk countries with poor credit records. In other words, the IMF reverses the normal banking practice of good lending: It rewards failure and punishes success. It rewards poor governance and excessive risk-taking by investors.

Requiring the IMF to charge market-determined interest rates on its loans would ensure that IMF loan recipients are held to the same standards for its loans as are private individuals and companies. There would be no special deals for bailing out rich investors who, unlike the average person with a bank loan, are saved from failure by government-subsidized loans. Moreover, this provision would minimize market distortions. It would reinforce market perceptions of risk and eliminate the backdoor transfer of wealth from Americans to the governments of countries that made unwise economic decisions.

4. IMF policies lead developing countries to economic stagnation and recession and foster dependency on foreign aid. Data collected over the past three decades demonstrate conclusively that most less-developed countries receiving IMF loans have the same or lower per capita wealth today that they had before they received the loans. Many actually are worse off. For example:

• Of the 89 less-developed countries that received IMF loans between 1965 and 1995, 48 are no better off economically today than they were before receiving IMF loans;

• Of these 48 countries, 32 are poorer than they were before receiving IMF loans; and

• Of these 32 countries, 14 have economies that are at least 15 percent smaller than when they received their first IMF loans.

Even a reformed, transparent IMF that recommends economic policies encouraging long-term growth would not deserve more funding. The Fund is ineffective in forcing countries to adopt reform and therefore cannot prevent future financial crises. Furthermore, the IMF repeatedly enters agreements with countries that have a history of violating their previous contracts with the Fund. For example:

• Peru made 17 different arrangements with the IMF between 1971 and 1977, and it continues to receive money from the IMF. The only results of these loans have been increased sovereign debt.

• The United States and the IMF bailed out Mexico four times since 1976. Each bailout followed a national election and was larger than the previous package. It is premature for the IMF to claim Mexico as a success story until at least after that country's next election. Recent high growth is no indicator of success; the last time Mexico had growth rates similar to today's levels was in 1982, before the Latin American debt crisis that was spurred by Mexico's repudiation of its debt.

5. Examination of IMF activities reveals that the organization is not functioning as a lender of last resort, as IMF and Treasury officials claim. Instead, it acts as a lender of first resort. The IMF had financial arrangements worth over $38 billion with 58 countries as of January 31, 1998.²⁰ In other words, the IMF currently is giving financial assistance to a third of its entire membership--indeed, over a quarter of the world's nations. Are we seriously to believe that every one of these 58 countries is in such dire financial straits that it is unable to secure private loans or investment, obtain foreign exchange through exports, or cut government expenditures sufficient to meet its debt obligations? Or that they are incapable of negotiating debt terms with their creditors? Of course not. The very fact that they are in debt indicates that they were able to secure credit. Moreover, if a quarter of the world's countries were indeed in such financial straits, global financial problems would be far beyond the capacity of the IMF to solve.

6. The IMF claims that it must act to help the people of a troubled country. This is false. Providing money to a government merely allows that government to meet its own debt obligations to both public-sector and private creditors. On one hand, an IMF bailout allows a government to pay its debts to large international banks; on the other, it allows a country to meet its short-term obligations to public-sector creditors, such as the IMF and the World Bank. In effect, therefore, instead of helping people in the country improve their economic condition, part of the IMF assistance is helping the country to pay off its debt to the IMF itself.

IMF rescues help neither the economies of recipient countries nor the majority of their citizens. In the wake of the Mexican bailout in 1995, for example, the Mexican people suffered a sharp decline in their standard of living, large increases in unemployment, and an overnight erosion of savings. Investors, however, escaped with minimal losses. This scenario has been replayed time and time again. Indonesia, South Korea, and Thailand all have experienced similar hardships despite IMF-led rescues. As in Mexico, the current IMF financial package in Asia salvages the profit margins of international lenders and large borrowers by guaranteeing their loans. Meanwhile, the citizens of these countries pay the tab on the rescue package through IMF-mandated higher taxes or currency devaluation (which reduce purchasing power and savings) in the hope that increased exports will provide the foreign exchange to pay an increased foreign debt.

7. IMF policies promote political instability. When confronted with the problems associated with IMF bailouts, defenders of the organization claim that all of the immense problems--including financial instability on a global scale, lack of transparency, massive transfers of wealth from U.S. taxpayers to Third World elites and international investors, and retarded economic development--are tolerable if IMF assistance can quell social or political instability.

Thus, it is no surprise that arguments in support of the International Monetary Fund usually are couched in the language of international crisis. Advocates of the IMF insist that without IMF guidance and assistance, countries would flounder inextricably in the "tar pits" of financial and political chaos. Nowhere, in fact, do we see a more consistent and zealous application of the view that developing countries are bound to fail, flounder, and decay without third-party assistance than at the IMF and at the other international agencies that complement its efforts.

Those who champion this argument:

• Fail to recognize the role IMF policies play in causing political instability. IMF bailouts aid international investors, well-heeled domestic businessmen, and others with connections to the ruling party. The typical citizens experience a sharp decline in their standard of living, large increases in unemployment, and an overnight erosion of savings. Moreover, the citizens of these countries pay the tab on the rescue package through higher taxes or currency devaluation (which reduce purchasing power and savings) in the hope that increased exports will provide the foreign exchange to pay a drastically increased foreign debt. This situation can do nothing but increase social and political instability in the countries being bailed out.

• Do not appreciate that IMF bailouts lead to successive blows to developing economies whose cumulative damage may exceed the damage of political instability. Simply put, the very existence of the IMF encourages imprudent--though, perhaps, not irrational--risk-taking by governments, big business, and their financial backers. The IMF's penchant for repeatedly intervening in financial crises and expanding the largesse of its bailout programs quite naturally means that the costs of risk-taking to the governments of those countries will be much lower than they would be otherwise. In fact, a reasonable assurance of IMF intervention most likely will mean that "subsidized" economies will collapse more quickly and powerfully than they would have without those assurances, leading to more frequent and intense political upheaval.

• Refuse to accept that IMF bailouts perpetuate the political power of administrations that have proven themselves short-sighted and inadequate managers.

• Fail to realize that many of the countries achieving successful economic and political development have done so largely without IMF assistance. In fact, most successes occur once countries are free from the central planning, high levels of taxation, and financial micromanagement advocated by international agencies such as the IMF. The United States achieved its political stability and economic prosperity without the aid of international bailouts from the IMF, despite economic setbacks as bad as those striking Asia. The more recent successes of Hong Kong, Singapore, and Taiwan likewise owe little or nothing to the IMF or its economic advice.

Solving the Problems: U.S. Influence in the International Monetary Fund

The only authority over the IMF is its governing bodies, established in its Articles of Agreement. In fact, the Articles of Agreement specifically state that the assets, archives, and employees are immune from searches and requirements demanded by judicial or legislative bodies of IMF member states. The Executive Board, which has 24 representatives, oversees the daily affairs of the IMF and the extension of financial assistance. The five largest contributors to the IMF (France, Germany, Japan, the United Kingdom, and the United States) appoint one representative each to the Executive Board. The remaining 19 directors are elected by different coalitions of countries and cast the cumulative votes of the coalition.

The Administration has steadfastly opposed any restrictions on U.S. funding or participation in the IMF. Instead, the Administration has reluctantly supported legislation contained in the Senate supplemental appropriations bill. Replacing earlier demands that the IMF implement reforms in exchange for access to U.S. funds, the Senate language only requires the Secretary of the Treasury to certify that the world's seven largest economies--the so-called Group of 7 (G-7) nations--agree to use their influence to push two specific reforms in IMF policies.²¹ These reforms would require countries to eliminate government subsidies and adhere to conditions outlined in trade agreements to which the country is party. These measures would largely reiterate previous legislation, would not address key issues (such as the disruptive impact of IMF subsidized loans), and would be unenforceable.

Congress should not fall victim to this facade of reform. It has attempted to implement desired reforms in the IMF through the "voice and vote" of the U.S. Executive Director for two decades with little or no change in IMF policy. These requirements have been largely ineffective. Consider the following:

• The Bretton Woods Agreements Act requires the Secretary of the Treasury to instruct the U.S. Executive Director of the IMF to "work in opposition to any extension of financial or technical assistance" from the IMF to any country permitting "entry into the territory of such country [of a person] who has committed an act of international terrorism [or] fails to take appropriate measures to prevent any such person from committing any such act outside the territory of such country."²² Despite this legislation, five of the seven countries listed by the U.S. State Department as sources of state-sponsored terrorism are members of the IMF and all but Sudan are fully eligible for IMF assistance.²³ In fact, Iraq owes the IMF some $42 million in delinquent payments dating back to 1990. Sudan, which has benefited from U.S. taxpayer money contributed to the IMF (including two IMF loans during the 1980s), currently owes $1.6 billion.²⁴

• The Bretton Woods Agreements Act requires the Secretary of the Treasury to instruct the U.S. Executive Director of the IMF to "actively oppose any facility involving use of Fund credit by any Communist dictatorship."²⁵ However, this restriction has been largely ineffective. During the height of the Cold War in the 1980s, Communist regimes in the People's Republic of China, the Hungarian People's Republic, and the Socialist Federal Republic of Yugoslavia, among others, received substantial financial assistance from the IMF.

• The International Financial Institutions Act lists in exhaustive detail reports on human rights abuses and lists the conditions under which the U.S. Executive Directors of the international financial institutions (including the IMF) should oppose financial assistance to countries "in gross violation of internationally recognized human right standards."²⁶ However, these instructions did not stop countries with dismal human rights records from receiving IMF assistance. For instance, the last two countries in the world that tolerate slavery, Sudan and Mauritania, are members of the IMF and have received hundreds of millions of dollars in assistance over the past 15 years--part of which was contributed and subsidized by American taxpayers.²⁷

• The International Financial Institutions Act instructs the U.S. Executive Directors of the international financial institutions (including the IMF) to promote a policy of requiring governments to reduce excessive military spending.²⁸ Yet, according to Russian affairs expert J. Michael Waller, vice president of the American Foreign Policy Council, the $20 billion in IMF financial assistance given to Russia since 1992 has funded Russian military activity in Chechnya, facilitated a sixfold increase in high technology and strategic weapon research and development expenditures, and contributed to the development of the next generation of Russian attack submarine--the Yuri Dolgoruki.²⁹

The problem is not a lack of legislated directives. Indeed, the two reforms outlined in the current Senate legislation would largely duplicate past legislation. As noted by Senator Mitch McConnell (R-KY), "section 14 of the [Bretton Woods Agreements] Act says it is U.S. policy to promote the removal of trade restrictions. Sections 44 and 49 tell our directors to work to eliminate agricultural subsidies."³⁰ So, since the very beginning of the international financial institutions, the United States has advocated a set of policy directives that have been largely ignored by the IMF.

How to Enforce Congressional Demands

Experience shows that attempts by Congress to reform the IMF or alter its policy through legislative directives to the U.S. Executive Director of the IMF are ineffective because:

1. Only in limited circumstances can the United States use its voting power to block IMF actions. Because of the IMF's voting structure, even the United States, which controls the largest block of votes in the IMF (17.78 percent), can block only those actions in the IMF that require an 85 percent majority, such as expansion of the quota subscriptions and amendments to the IMF Articles of Agreement.³¹

The United States is essentially unable to push through fundamental reforms unless it gains an additional 52 percent to 63 percent of the votes. It cannot prevent the organization from extending financial assistance, which under normal circumstances requires a simple majority of votes cast, unless it has garnered the support of an additional 33 percent of the votes.³² This means that the IMF can extend loans over the objection and negative vote of the United States.

2. Congressional instructions to executive branch officials are ineffective. The U.S. Executive Director is technically not bound by Congress's instructions on how to vote or speak in his official capacity. Congressional instructions are more like suggestions or guidelines than ironclad rules. Through the constitutional division of powers, the President can countermand congressional instructions to executive branch employees. Congress's directives are enforceable only within its sphere of constitutional powers, such as the power of the purse.

For example, Congress is within its power to restrict access to authorized or appropriated funds on condition of certain actions. Hence, the provisions in H.R. 3331. However, past legislative efforts to reform the IMF through instructions to the U.S. Executive Director have been undermined by the lack of congressional authority to require that official to take specific actions. Moreover, congressional instructions are often weakened further through waivers, such as a national security waiver, that allow the President to circumvent congressional guidelines.

3. Existing legislation contains no absolute requirements to encourage the IMF to adopt reform. I would like to congratulate Representative Bernard Sanders (I-VT) of this committee on his foresight in requesting the Congressional Research Service to compile a report on past legislative efforts to reform the IMF. Over 30 different requirements on IMF activities, IMF reforms, and instructions to the U.S. Executive Director of the IMF on how to use his "voice and vote" have been passed by Congress and signed by the President in the past two decades, according to the report.³³ The problem is not a paucity of instruction; it is a lack of enforcement. Past legislation to reform the IMF or its activities has lacked any meaningful enforcement measures or consequences if the legislation is ignored. As noted by Senator McConnell, "We do not need to pass more legislation urging the administration to use our voice and vote to assure a loan meets a congressional mandate. Instead, we need to see the IMF Executive Board or the Board of Governors pass and implement resolutions agreeing to standards already enunciated in the U.S. law."³⁴ If Congress is serious about reforming the IMF, it must attach palpable and effective enforcement mechanisms to its requirements.

Congress must rely on its constitutional powers, specifically the power of the purse, if it wishes to enforce certain actions. Specifically, Congress must demand that desired reforms are implemented before funds are distributed, and require annual confirmation of required reforms to maintain access to previously appropriated funding. One bill that would implement these safeguards is H.R. 3331, the IMF Transparency and Efficiency Act of 1998.

H.R. 3331 orders the Secretary of the Treasury to submit a written certification to the Senate Committee on Banking, Housing, and Urban Affairs and to this committee, the House Committee on Banking and Financial Services, on the status of the reforms specified in the legislation six months after the enactment of the bill. Once the Secretary of the Treasury submits the certification, Congress must enact a joint resolution verifying and approving it before the funds are made available.

This provision would ensure that Congress has an opportunity to examine and review IMF actions and confirm that the reforms stipulated in the bill have been implemented. Moreover, the certification must be renewed annually. This would prevent possible backsliding and recidivism on the part of the IMF, or deceptive action on the part of Treasury officials.

If the Secretary of the Treasury fails to submit the certification, or if Congress finds fault and fails to pass a joint resolution supporting the certification, H.R. 3331 forbids any "officer, employee, or agent of the United States [to] directly or indirectly, provide Federal funds to the International Monetary Fund." This provision is far more effective than prohibiting the current appropriation because it would freeze all U.S. funds committed to the IMF--past, current, and future--that are not already in the IMF coffers.