April 1, 1999 | News Releases on International Organizations

New Study Analyzes IMF Policy Failures in Asia

WASHINGTON, APRIL 1, 1999-As the International Monetary Fund prepares to dole out billions of dollars in additional loans to Russia, a new Heritage Foundation study on the IMF's recent policy blunders in Asia offers policymakers a cautionary tale.

After the IMF bailout of Mexico in 1995, investors gained confidence that the IMF would bail out any large international debtor country, according to Heritage Senior Fellow in Economics Gerald O'Driscoll, a former economist with the Federal Reserve Bank of Dallas. That led to lots of questionable loans to Asia, since investors knew the IMF would rush in if Asian economies faltered, he says.

The IMF unwittingly created what economists call a "moral hazard," says O'Driscoll, who most recently served as vice president and director of policy analysis for Citigroup. By creating an insurance policy to protect investors in the event that risky loans failed, the IMF encouraged risky loans.

"After the Mexico bailout, the existence of moral hazard in international lending became a fact in capital markets and cannot be dismissed as the speculation of free-market economists," O'Driscoll says. "That some within the IMF still question its existence is testimony to this agency's continuing state of denial."

The IMF's misguided bailout of Mexico led to the Asian economic crisis, O'Driscoll says. In response, the IMF decided to bail out Asia as well. IMF assistance to Thailand now totals $17.2 billion, and South Korea's commitment from the IMF and other creditors stands at $57 billion.

To O'Driscoll, this is treating the problem with the problem. "At each step in the [Asia] crisis, the IMF applied as solutions programs that contributed to the crisis in the first place," he says. "The agency's policies unfortunately have laid the groundwork for future financial crises."

Although the IMF's bailout of Thailand, Indonesia and South Korea came with a list of required reforms, progress has been slowed by political opposition in the these countries. O'Driscoll says this underscores another problem-the limits of the IMF's influence. What's more, "IMF intervention generates a nationalist and populist backlash" and encourages anti-American feeling because the IMF is perceived "as a mere instrument of U.S. policy."

In the short term, O'Driscoll says, an attractive alternative to IMF bailouts would be for economically floundering countries to resist calling in international bureaucrats and instead rely on the advice of U.S. bankers and lawyers with experience helping debt-strapped clients. But since O'Driscoll concedes this is unlikely (the lure of IMF money proves too strong), at the very least countries should allow foreign banks and securities firms to establish local branches-a "critical element of reforming the financial sector," he says.

In the longer term, fundamental IMF reform is essential, O'Driscoll says. Congress took a first step in that direction with the 1999 Omnibus Appropriations Act, which mandates actions U.S. officials must take before the IMF can release funds. But the legislation failed to specify reforms the IMF should make. If Congress is dissatisfied with the IMF, says O'Driscoll, "it should express its concerns to Secretary of the Treasury Robert Rubin and Deputy Secretary Larry Summers. IMF policy originates with them and can be altered by them."

Congress should also make its influence felt through oversight hearings and the power of the purse, O'Driscoll says. In this way, lawmakers can hold the IMF accountable, which is crucial since international organizations are "by their design insulated from such democratic accountability."

About the Author