May 6, 1997 | Backgrounder on International Organizations
Founded 53 years ago in the turbulent era of the 1940s to stabilize the world economy, the International Monetary Fund (IMF)1 has become outdated, ineffective, and unnecessary. Most of the economic conditions that led to the IMF's creation no longer exist; in addition, the Fund has failed to achieve most of its own newly defined roles, a preponderance of which merely duplicate the functions of other existing agencies and organizations.2
When the IMF was founded, economies around the world were in shambles following the Great Depression of the 1930s and the devastation of World War II. The poor economic policies pursued by many countries during the 1930s had left currency values uncertain, hindering trade. Those who created the IMF believed that it could help restore confidence in the world's currencies by establishing a specified value for each currency in relation to an amount of gold, a practice known as the gold standard. The IMF maintained these values by infusing money into world financial markets, but its efforts had mixed results.
When the gold standard was abandoned in 1971, it was replaced by a "floating" exchange rate system that allowed currencies to fluctuate in value. Bereft of its old mission, the IMF chose a new one: to act as a development bank for poor countries. The data for the past three decades, however, demonstrate conclusively that most of the less developed countries receiving IMF loans have the same or lower per capita wealth today than they had before receiving these loans. Many actually are worse off economically:
Many of the missions the IMF has chosen to undertake do not require any involvement by the Fund. Congress should examine the IMF's overall effectiveness in accomplishing its stated purposes, as well as its impact on poor and developing countries. If it does, it will find that the IMF more often than not has failed to advance the purposes for which it was founded and has contributed little to improving the economies of less developed countries. It is time for Congress to develop a legislative strategy to end the contribution to the IMF. Specifically, Congress should:
The IMF was founded in 1944 at a meeting of 44 countries at Bretton Woods, New Hampshire. It began operations in Washington, D.C., in 1946 with 39 member states and initial resources of $7.6 billion, contributed by 35 member states in 1945.5
Since then, the IMF has become a large multilateral organization with 181 member states. Its financial operations have been divided into three broad accounts: the General Department,6 Administered Accounts,7 and the Special Drawing Rights (SDR) Department.8 Each account has its own specified purposes. Currently, IMF members provide over $220 billion a year to fund the organization's efforts.9
The IMF's record of success is spotty at best. There is scant evidence, for example, that it contributed to the stabilization of exchange rates after its creation. Moreover:
The Fund set, or "pegged," currency values relative to gold in a manner that allowed for slight adjustment. For example, the Mexican peso might be set at 100 pesos per ounce of gold. If, however, Mexico's economic policies devalued the currency to 150 pesos per ounce of gold, the IMF would step in to buy pesos on world financial markets, coordinating this action with instructions to Mexico on how to alter its economic policies accordingly. The IMF would increase the value of the peso artificially until it reached the 100 pesos per ounce of gold mark.10 This system, called the gold standard, operated from the end of World War II until 1971, at which time the United States led the world in abandoning the gold standard.11
After 1971, instead of using a commodity like gold to "fix" exchange rates, the world allowed currencies to fluctuate in value when measured against other currencies. This process is known as a floating exchange rate system. With the gold standard eliminated, the IMF no longer had to maintain currency value in relation to gold. The main reason for its existence had disappeared.
Moreover, not only are IMF resources dwarfed by those of the private sector, the IMF also lacks the ability to make the rapid responses necessary to affect exchange rate fluctuations. World currency values adjust on a minute-by-minute basis; the IMF's reaction time is measured in days, weeks, or even months. In many cases, by the time the IMF reacts, a country already will have suffered the consequences of its currency's collapse--a collapse caused by the government's own financial mismanagement. In some cases, the country actually may be recovering by the time the IMF acts. For example, the Mexican bailout of 1994 went into effect months after the fact, by which time Mexico's economy already was adjusting to the crisis and beginning to recover.
Although private investment is growing and investors are eager to enter less developed countries, they are experiencing competition for investment opportunities from public investment sources like the IMF. Directly following the collapse of the Soviet Union, the IMF and World Bank rushed into many newly free countries in Eastern and Central Europe, and private investors often found themselves competing with these large institutions for investment opportunities. In other words, the IMF and other public sources of public investment crowd out private investment.
Much about the international economy has changed since the end of World War II. In addition, much of what the IMF has done has resulted in failure. The IMF remains ineffective because:
For example, between 1965 and 1995, 137 countries received loans from the IMF. For 81 of these countries, the number of times they borrowed from the IMF between 1981 and 1995 increased an average of nearly 50 percent over the number of times they borrowed between 1965 and 1980. Only 44 countries reduced the number of times they borrowed during the same periods; 12 maintained activities at similar levels.15 This means the IMF is extending loans to more countries with greater frequency than it has in the past, thereby involving greater total amounts of assistance than was the case before 1980.16 Thus, the IMF has not been able to ensure that its loans to less developed countries are indeed in the short term. Instead, these loans have been more likely to create long-term dependence.
For example, in order to receive an IMF loan, a recipient country may be required to impose a host of specific economic policies, such as balancing its budget, devaluing its currency, maintaining tariff levels, or keeping tax rates high. Unfortunately, such requirements can prevent less developed countries from achieving significant, long-term economic reform. For example, the governments of many less developed countries maintain high levels of spending on unprofitable state-owned businesses, and this spending often creates huge budget deficits (as was the case in many Latin American economies during the 1980s). To qualify for loans from the IMF, therefore, a country may be required to reduce its budget deficit. The problem is that this country may try to comply by raising taxes, raising tariffs to increase revenues, or devaluing its currency by printing more money, thereby causing more inflation.
These policies seldom result in lower budget deficits or reduced international debt. Rather, they drive economies further into stagnation. Bolivia, for example, has received loans from the IMF every year except three between 1985 and 1995. Each time, it was supposed to reduce its budget deficit; instead, its budget deficit grew by over 8,000 percent from 1985 to 1993.18 Moreover, Bolivia's external debt also soared.19 Bolivia received its first IMF loan in 1968. In 1970, it had a total external debt of only $497 million; by 1993, that debt had swelled to over $4 billion.20
For example, Peru entered into 17 different arrangements with the IMF between 1971 and 1977, and continues to receive money from the IMF today.21 During the same period, Peru failed to meet the conditions for most of these agreements. Instead, the government continued its self-destructive economic policies. For example, in 1971, Peru's external debt was $2.7 billion; by 1977, Peru had signed 17 agreements with the IMF, yet its external debt had soared to over $9 billion.22 Even though Peru failed to meet the conditions for these agreements, it continued to receive IMF funding.
- From 1968 to 1995, Nicaragua received approximately $185 million in IMF loans. In 1968, per capita gross domestic product (GDP), measured in constant 1987 U.S. dollars, was $1,821; in 1993, it was only $816, or 55 percent less than it had been before Nicaragua received any loans.
- From 1972 to 1995, Zaire received approximately $1.8 billion in IMF loans. In 1972, per capita GDP, measured in constant 1987 U.S. dollars, was $683; in 1993, it was only $317, or some 54 percent less than it had been before Zaire received any loans.
The inescapable conclusion is that IMF efforts to encourage economic growth have been dismal failures. Whether this has been caused by the recipient countries' poor adherence to IMF policy prescriptions or by flaws within these prescriptions themselves does nothing to alter this conclusion. Harvard economist Jeffrey Sachs believes both may be at fault: "Countries that comply with IMF/WB [World Bank] programs seem to outperform countries that do not. At the same time, however, even countries in compliance with IMF/WB programs experience poor to mediocre growth performance."25
Even those who agree that the IMF is outdated and recognize its ineffectiveness may claim that there remains a need for an organization like the IMF. This is not the case. The Fund duplicates the duties and functions of other major international organizations, in addition to engaging in activities that are unnecessary:
The IMF no longer is needed (if it ever was) to establish this kind of multilateral system. A system of multilateral currency exchange has existed in one form or another since the onset of international trade; it has existed formally since the end of World War II. There is no evidence that the IMF has had any impact in forcing less developed countries to comply with the established multilateral system of exchange. In fact, the most compelling reason for these countries to abide by the conditions of the current multilateral system is that failure to do so will render them unable to borrow money from private and public sources, attract foreign investment, or trade with other countries.
Moreover, even if one assumes that the IMF played a marginal role in getting countries to subscribe to international standards for the global currency exchange and trading system in the past, the World Trade Organization now is responsible for overseeing and maintaining the system of international trade. The WTO provides a forum within which countries can seek to reduce current and future barriers to trade and investment, discuss problems in the system, and recommend solutions to those problems.
Moreover, the IMF both judges the creditworthiness of members and approves new loans to those same members. This encourages low-income member states to overlook the failure of other less developed countries to repay their loans. If the IMF deems a country unworthy of credit, it is likely that private lenders also will deem that country a credit risk and refuse to lend it the requested funds. In addition, the World Bank--the largest multilateral source of development assistance--is forbidden by its Articles of Agreement to extend loans to countries that do not meet IMF approval. Thus, IMF disapproval severely limits access to credit. Developing countries therefore refuse to sanction other countries because they fear the same thing could happen to them.
The IMF system, in other words, is based on an inherent conflict of interest. It is like allowing borrowers who have defaulted on their car loans to approve their own applications for new home mortgages.
The facts show that the IMF has failed to fulfill many of the goals for which it was created. In particular, it has failed at its newest mission: promoting economic development. There is no justification for continuing to support any organization that lacks a viable purpose, especially when that organization costs the U.S. taxpayer as much as the IMF does.
Like many other international programs, the IMF is able to avoid having to rely on annual congressional appropriations. Instead, it relies on occasional "replenishments" from donors. The last time the IMF was replenished by Congress was in 1992. Although the replenishment issue may not come before Congress this year or next, some new initiatives will. One such initiative currently being considered is the NAB program. The IMF claims this is a supplemental fund, to be used on a short-term basis. In reality, however, it is another way for the IMF to ask the United States to fund more of its activities before the next replenishment. Proponents--primarily the IMF and the Clinton Administration--argue that such a program is needed to prevent international financial crisis. The IMF recently argued that its experience with the Mexican peso crisis in 1994 demonstrates that it should act as a global police officer to keep such situations from occurring.
Yet the IMF conveniently overlooks the fact that Mexico has received billions from the World Bank and from the IMF since the 1970s, including some $24 billion from the IMF alone. The Fund also overlooks the fact that it has bailed out Mexico four times since 1976, with each bailout corresponding to a national election. This leads to an obvious question: If the IMF is needed to prevent such economic crises as the collapse of the peso, why was it unable to prevent the previous four economic crises in Mexico? Clearly, the IMF overlooked the Mexican government's self-destructive economic policies. Lending more money to Mexico without enforcing the conditions established in the agreements merely allows Mexico to keep pursuing its faulty policies.
Policymakers should develop a legislative strategy to achieve the goal of withdrawing all U.S. financial support from the IMF. This will draw criticism from those who seek to preserve such programs because they benefit from them politically. Thus, policymakers who seek to eliminate U.S. funding for the IMF should be prepared to meet these criticisms head-on, emphasizing the fact that the IMF does more harm than good in less developed countries. Specifically, they should:
- The economic performance of IMF loan recipients;
- The effectiveness and efficiency of IMF programs in meeting the organization's stated goals;
- The effectiveness of the IMF in getting recipient countries to adopt specific economic policies; and
- The need to conduct an audit of the IMF's financial records.
Since 1965, the International Monetary Fund has spent $170 billion to achieve its stated goals.29 Although the question of whether the IMF was needed in the first place may be debatable, the fact that it is outdated, ineffective, and unnecessary today is not. The IMF lost its primary mission when the international financial system moved away from the gold standard to a floating exchange rate system. It also is clear that the IMF's approach to economic development has been a colossal failure. Most countries that have received IMF loans since 1965 are no better off economically than they were before these loans. In fact, most are poorer today. Much of what the IMF has done over the past several decades has been unnecessary at best and destructive at worst.
Despite the overwhelming evidence of the futility of IMF practices, however, the Clinton Administration continues to ask for U.S. tax dollars to subsidize the Fund's operations. U.S. policymakers should admit that the IMF has failed. Congress should refuse to appropriate any new money for the IMF after its current replenishment expires. Not only would this save U.S. taxpayers billions of dollars, but it could force countries in the less developed world to break the economic chains that keep them impoverished, thereby improving their economies--and the global economy--for decades to come.
Table 1: Economic Growth Rates of Recipients of IMF Loans and Purchases (Algeria-Kenya)
Table 1 Con't (Korea-Zimbabwe)
Table 2: Countries Increasing Their Activity with the IMF (Albania-Kazakstan)
Table 2 Con't (Kenya-Zimbabwe)
Table 3: Counties Decreasing Their Activity with the IMF
Table 4: Countries Maintaining Their Level of Activity with the IMF
6The General Department is the core of the IMF and handles the functions granted the organization in the original version of the Articles of Agreement. It includes the General Resources Account (GRA), which includes quota payments and borrowed resources such as the General Arrangements to Borrow (GAB), and the Special Disbursement Account, which administers the development funds of the IMF, known as the Structural Adjustment Facility (SAF) and the Enhanced Structural Adjustment Facility (ESAF). A proposed New Arrangements to Borrow (NAB) account will be placed under the GRA.
8The Special Drawing Right (SDR) Department tracks all transactions and operations involving the SDR and is responsible for allocating and handling related duties, such as determining interest rates on the SDR. The SDR is an international reserve, interest-bearing asset created by the IMF in 1969, and is a unit of account on all IMF transactions. For SDR value determination, see Appendix, Table 2, "Number of Years Countries Received IMF Aid." Typically, an SDR is equivalent to about $1.50.
17Due to the IMF's secretive nature, it is impossible to determine the exact conditions of a specific IMF agreement with a given country. The IMF, however, is often frank about its requirement that recipients reduce the size of their budget deficits. See International Monetary Fund, "Ten Common Misconceptions About the IMF," 1988.
23This calculation is based on comparisons of the gross domestic products (GDPs) of IMF recipients during their first year as recipients and the per capita GDPs of these countries in 1993. All figures are expressed in constant 1987 dollars. This figure includes countries whose economies grew less that 1 percent a year, expressed in per capita terms, for the period measured.
26John Sweeney, Bryan T. Johnson, and Robert O'Quinn, "Building Support for Free Trade and Investment," in Stuart M. Butler and Kim R. Holmes, eds., Mandate for Leadership IV: Turning Ideas Into Actions (Washington, D.C.: The Heritage Foundation, 1997), pp. 629-668.
28International Monetary Fund, "Financial Organization and Operations of the IMF," Pamphlet Series No. 45, 4th ed., September 1995, p. 27. This does not include either creation of or increases in the Administered Accounts.
29Total purchases and loan disbursements between 1965 and 1995 for all countries receiving SDRs from the IMF were added to arrive at this figure; International Monetary Fund, International Financial Statistics Yearbook 1996.