Dominique Strauss-Kahn and the IMF

from Dean Baker

Those who hoped for serious reform of the International Monetary Fund have to be very disappointed by the allegations of sexual assault against its director, Dominique Strauss-Kahn. If the charges prove true, this will end Strauss-Kahn’s efforts at reforming an institution that is badly in need of reform.

Most people around the world do not realize the power that the IMF has in controlling their lives. In fact, in many countries the IMF’s actions probably have more impact on their well being than the decisions of their elected government.

Some countries are well acquainted with the IMF’s power. In the East Asian financial crisis the IMF, acting under the instructions of the Clinton Treasury Department, imposed very harsh terms on the countries of the region, insisting that debts be repaid in full. In effect, the IMF acted as the head of a creditors’ cartel, maximizing the amount of money that U.S. and European banks could collect on loans that otherwise would have been written down by large amounts.

The IMF played the same role in other countries that faced crises at the end of the decade, most notably Brazil, Russia, and Argentina. Russia’s economy faced severe recession until it finally broke with the IMF in the summer of 1998. This break, while originally painful, provided the basis for a decade of strong growth.

The battle with Argentina was even more striking. The austerity imposed on the country pushed its economy ever deeper into recession. Finally, in December of 2001, with civil unrest undermining the government’s authority, the country had no choice but to abandon the IMF program and default on its debt.

The IMF then did everything in its power to undermine Argentina’s economy. It even produced economic projections that consistently and hugely underestimated Argentina’s growth as part of an effort to destroy confidence in the country’s economy. Remarkably, the IMF’s sabotage efforts failed. After a quarter of free fall, Argentina’s economy stabilized and then began growing robustly in the second half of 2002. It continued to experience strong growth until the world recession brought its economy to a standstill in 2009.

It was not just the crisis countries that were affected by IMF policies. Countries throughout the developing world took away the lesson that they did not want to be in a position where they were forced to turn to the IMF for support. In order to protect themselves, they began to accumulate massive amounts of reserves.

This meant running huge trade surpluses. The result was that instead of capital flowing from rich countries to poor countries, which is the basic story in every economics textbook, capital flowed from poor countries to rich countries, most notably the United States.

Of course things didn’t turn out fine. The trade imbalances helped to support massive housing bubbles in the United States and several other wealthy countries. When these bubbles burst in 2007-2008 it threatened the survival of the world financial system and threw the economy into the worst downturn since the Great Depression.

Tens of millions of people remain unemployed as a result of this collapse. The lost output to the world as a whole is likely to exceed $10 trillion.

Remarkably, not a single person in the IMF’s leadership or bureaucracy was fired or even demoted for this enormous policy failure. The IMF’s own Independent Evaluation Office decried the groupthink that prevented the thousands of economists working for the institution from recognizing and warning of this imminent disaster. Of course as long as no one ever gets fired for agreeing with the boss no matter how wrong the boss is, it’s a safe bet that career-minded individuals will agree with the boss.

Dominique Strauss-Kahn tried to shake up this institution. He brought in Olivier Blanchard from MIT, one of the world’s most prominent macroeconomists, as the IMF’s chief economist. He gave Blanchard a free rein, which he quickly used to harshly criticize the orthodoxy within the IMF.

Last fall, the IMF published a study in its World Economic Outlook that showed that fiscal austerity in the wake of the economic crisis would further contract demand and raise unemployment. This reversed the institution’s historic role; the IMF officially became a voice for expansion and employment rather than contraction and austerity.

Of course the story at the country level was often quite different. The teams that imposed specific terms for IMF support are well entrenched. Their plans for “internal devaluations” (declining wages and prices) in countries like Estonia and Latvia pushed their unemployment rates to nearly 20 percent. Getting the country-level teams in line with any new thinking at the top was likely to be a long and difficult process even in the best of circumstances.

If the charges against Mr. Strauss-Kahn hold up, then he will not be around to carry this effort forward. As far as for what the future holds, his interim successor, John Lipsky, was a former vice president at J.P. Morgan. This could mean that the whole world will suffer for Mr. Strauss-Kahn’s criminal conduct.