November 2, 2007 | Commentary on International Organizations

Leaner IMF

A job for the new Fund leader.

The International Monetary Fund gets a new boss today. Maybe now it can find a useful purpose.

Dominique Strauss-Kahn, a former French finance minister and presidential candidate, is taking over an aged institution with no clear raison d'etre. The IMF was originally created to help prevent a recurrence of the protectionist economic policies and competitive currency devaluations that exacerbated the Great Depression and helped spark World War II. The IMF was the "mechanic" in charge of the Bretton Woods system charged with making sure each nation's currency stayed within the narrow range under a system of fixed exchange rates.

Unfortunately for the IMF, time passed it by. The system of fixed-exchange rates began to break down in the late 1960s and early 1970s. The United States loosened the dollar peg to gold in 1968 and discarded it completely in August 1971.

This left the IMF an institution without a cause. But instead of folding its tent, or at least reducing its activities, the bureaucracy dreamed up new missions to justify its continued existence.

The IMF reinvented itself to become crisis cashier and counselor to the world. Moving from crisis to crises -- from the oil crisis of the 1970s to the more recent financial meltdowns in Asia and Latin America -- the IMF steadily applied its newfound nostrum: ever more lending to developing nations, always dispensed with economic policy prescriptions.

Today, the IMF finds itself in a quandary. IMF recipients often resent IMF policy prescriptions and, given a choice, would rather not borrow from the Fund. With few economic crises in recent years, it can't find any customers. Increasingly, countries with access to international capital markets try to tap them, rather than accept IMF assistance and the accompanying restrictions. Countries like Angola borrow from China rather than bow to IMF demands. Latin American finance ministries want to create a "Bank of the South" as a less strict competitor to the IMF when Latin countries face economic or balance-of- payments crises.

How bad is it? The Washington Postreports that, though "famous for its bailouts of troubled developing countries" a decade ago, the IMF now has "only $11 billion in credits outstanding; it is sitting on $252 billion in usable resources." This is quite worrisome for the Fund because it makes its money from lending. Needless to say, its books have plenty of red ink these days.

The challenge facing Strauss-Kahn is to reshape his antiquated institution to serve a useful purpose in the rapidly changing global economic system. He has vowed reform, telling his Board of Governors, "it will be a hard task for all of us to rebuild both the relevance and legitimacy of this organization. But I am prepared to do that and I ask you to be prepared as well."

Unfortunately, Strauss-Kahn's vision of a rebuilt IMF may not be very realistic. Even while confessing the need to "examine" its size and functions, reduce expenses and develop a sound source of income, he articulated a rather dubious conclusion: "We don't need less IMF, we need more IMF."

Why? Because in his view, the IMF must "make financial stability serve the international community, while fostering growth and employment." This is an exceptionally grandiose mission statement that defies reality.

The days when an IMF could arrest serious global financial crises are past. Today's global markets facilitate the flow of trillions of dollars in private capital. IMF's less than $300 billion in useable resources can't possibly counter private capital flows. The IMF bailout "bucket" is simply too small to solve serious financial crises. Worse, attempts or implicit promises to perform such a role may well increase market volatility, creating a moral hazard that encourages imprudent risk-taking by governments and investors.

Still, the IMF possesses one relevant resource: Its expertise and experience in providing sound economic and financial advice. The IMF seal of approval still carries weight.

That's key, because international markets and private capital flows react to policies. Prudent polices attract investment and access to capital: poor policies scare off investment and freeze credit. Governments should use the IMF as an impartial consultant on economic policy that will help them transition toward greater economic freedom. Enhancing economic freedom is crucial to economic growth in our increasingly integrated global market. Countries with higher degrees of openness and flexibility enjoy sustained economic growth and the prosperity that comes with it. This relationship has been documented year after year in The Index of Economic Freedom, published annually by the Heritage Foundation and the Wall Street Journal.

The IMF can never again be what it was. Strauss-Kahn should drop the delusions of grandeur and reform the IMF into a lean international consultancy focused on promoting economic freedom. Obviously, this more modest role would not require the Fund's current resources and the IMF should return most of its resources to the member states. While not as dramatic as organizing bailouts or crisis management, this realistic role would certainly advance the IMF's historical mission of promoting international financial stability and its stated desire to promote economic growth and development.

Brett D. Schaefer is Jay Kingham Fellow in the Heritage Foundation's Margaret Thatcher Center for Freedom. Anthony B. Kim is a policy analyst in Heritage's Center for International Trade and Economics.

About the Author

Brett D. Schaefer Jay Kingham Senior Research Fellow in International Regulatory Affairs
The Margaret Thatcher Center for Freedom

Anthony B. Kim Research Manager, Index of Economic Freedom, and Senior Policy Analyst
Center for Trade and Economics (CTE)

Related Issues: International Organizations

First appeared in the National Review Online