Crises and recoveries: multinational failures and national successes.

• Author: Reynolds, Alan

The overused phrase "economic crisis" became surprisingly familiar over the past decade, being more often used than the word "panic" a century ago. The more the International Monetary Fund attempted to predict and repair economic crises, the more unpredictable and irreparable such crises have seemed to be. Perhaps the cure is not helpful. Perhaps the cure is the more serious disease.

Criticism of IMF lending generally focuses on two issues: (1) the allegedly counterproductive impact of IMF-demanded adjustment programs on the borrowing countries' economic performance, and (2) the moral hazard effect in which the sheer availability of loans at below-market interest rates encourages more national politicians and their foreign lenders to take imprudent and excessive risk.

This paper will focus on the first point, but I believe it is closely related to the second. If IMF-required policies are perceived of as leaving the country with less income and more debt, then we should expect them to be poorly received by financial markets. In 1997-98, the Korean stock market fell very sharply shortly after the IMF program was revealed, Indonesia's credit rating was downgraded after the IMF program was revealed, and Russia devalued and defaulted a few weeks after the IMF program was revealed. Lane and Phillips (1992) suggest "weighing the possibility of moral hazard against other implications of the availability of IMF financing in alleviating the effects of crises." I suggest there is no such trade-off: IMF loans involve moral hazard and IMF programs aggravate rather than alleviate economic crises.

My past work on this topic consisted of event studies demonstrating that two conditions commonly attached to IMF loans invariably cause or aggravate inflationary recessions, thus making countries poorer and less able to service their debts (Reynolds 1998a, 1998b). The generic idea that IMF policies are harmful is no longer the heresy it was in the early 1980s, when I began to document the IMF's track record (Reynolds 1985). Joseph Stiglitz (2000) and many others (e.g., Henderson 1999, Hanke and Baetjer 1997) have recently condemned IMF advice as harmful. Much of this criticism, however, comes from within the IMF's own Keynesian demand-side framework (Lindsey 1998; Schultz, Simon, and Wriston 1998).

I differ mainly by emphasizing the importance of structural, microeconomic tax policy in both crises and recoveries. The IMF's director of research, Kenneth Rogoff, found Stiglitz's criticism similar to that of "extreme expositors of 1980s Reagan-style supply-side economics" (Rogoff 2002). Intended as a slur, that remark reveals typical IMF misunderstanding of the difference between a demand-side and supply-side approach. As early as 1981, World Bank economist Keith Marsden observed that "South Korea, Singapore, Malaysia, Mauritius, the Ivory Coast and Brazil are among the countries that have pursued supply-side policies for several years" (Marsden 1981: 2). The IMF's usual advice, by contrast, resembles that of U.S. President Hoover, who enacted prohibitive tariffs in 1930 and tripled income tax rates in mid-1932. The usual results are also similar.

I disagree with those IMF critics (including Stiglitz) who complain about fiscal austerity in the Keynesian sense--making no distinction between punitive taxation and protectionist tariffs on the one hand and frugality in government spending on the other. In my view, government purchases compel the private sector to compete for resources, damaging the profitability of private investment (Alesina et al. 2002). Government transfers are a disincentive for both those who receive the benefits and taxpayers who pay. In this respect, my event studies confirm the cross-country studies of Alesina et al. (2002) and Barro (1991) who find reductions in government spending to be expansionary--conducive to economic growth--while higher tax rates are contractionary.

Ireland slashed government spending by more than 7 percent of GDP in 1986-89, but the results were the opposite of those predicted by a demand-side model. They also cut the tax on corporate profits to 15 percent and cut the tax on indexed capital gains to 20 percent. As a recent IMF report puts it, Ireland also "significantly reduced the exceptionally progressive nature of the progressive tax structure and increased work incentives." What happened? Economic growth from 1989 to 2001 averaged 7.2 percent per year. The IMF now views such prosperity as evidence of insufficient tax effort: "Although Ireland's effective tax rate on consumption is already relatively high," says an August 2002 IMF report, "increased effort in this area could be achieved" (Cerra and Soikkeli 2002). Fortunately, Ireland is in a position to ignore such IMF lectures.

Some IMF programs that concern, say, national labor market regulations may be constructive but they are nonetheless unjustifiable objects of neocolonial meddling (Chari and Kehoe 1998). In any case, my own criticism is limited to only two perennial IMF themes: (1) recommendations of higher tax rates to meet dubious targets for the budget deficit, and (2) recommendations of massive and deliberate currency devaluations to meet dubious targets for the current account deficit. These are ineffective policies aimed at inappropriate objectives, involving destructive methods of eliminating hypothetical "twin deficits" in budgets and current accounts.

This paper reviews and updates some of my past work in order to make a different point--namely, IMF policies cannot possibly take credit for post-crisis recoveries unless IMF policies remained in place. But whenever the key IMF policy tools of increasing tax rates and devaluing currencies have remained in place (e.g., Turkey except during the mid-1980s and Argentina except the early 1990s), recoveries are weak, rare, and brief.

IMF Programs in Crises, National Programs in Recoveries

Most countries naturally recover from crises after a year or so, even though a few keep repeating the same mistakes (and are rewarded with IMF loans for doing so). Mexico recovered after 1995, for example, as did the East Asian countries and Russia after 1998. The fact that crises are normally temporary, just as they were before the IMF existed, makes it much too easy for the IMF to claim that it deserves zero blame for the bad years but ample credit for the good ones.

One reason the usual before-and-after comparisons are not credible is that economic...