The IMF and us

Over the years, the IMF has emerge­d as a key influe­nce on Pakist­an’s macroe­conomi­c polici­es.

Over the years, the International Monetary Fund (IMF) has emerged as a key influence on Pakistan’s macroeconomic policies. Since the late 1980s, it has been imposing various conditions on successive governments increasingly crippled by debt servicing. Surprisingly, one finds that almost all discussion centres on Pakistan’s failure to meet targets set by the IMF and hardly any on what ‘success’ might mean for Pakistan’s own development.

Typical IMF conditions comprise contractionary macroeconomic policies (fiscal and monetary), inflation targeting regimes, financial deregulation and increased openness to international capital flows, trade liberalisation (including reduction of tariff and non-tariff barriers) and privatisation of public-sector enterprises. In short, an abandonment of state-led development strategy. Given space constraints, let us confine ourselves for the time being to analysing the effect of IMF conditions on fiscal policy in general and government spending in particular.

One might begin by asking what the aim of macroeconomic policy should be in a developing country. First and foremost, it should facilitate and never impede long-run development goals. There is enough evidence now to suggest that it should also be counter-cyclical. In other words, government spending should expand to fill in for a fall in private spending during a downturn and contract during an upturn. The IMF’s argument that government spending will crowd out private investment does not stand up to scrutiny, nor is it backed by empirical evidence. Indeed, as research by the United Nations Conference on Trade and Development (UNCTAD) and the United Nations Development Programme has shown, government spending, especially on infrastructure, health, education, technology and communication, has actually had the effect of  ‘crowding-in’ private investment in a number of countries (UNCTAD 2003, Roy and Weeks 2004). This is especially true in times of crisis when private investors become even more risk averse.

It is difficult to see how the IMF’s recommended contractionary policies aimed at controlling inflation and reducing the deficit are consistent with Pakistan’s development goals. Indeed, a recent study by the Centre for Economic Policy Research (CEPR) finds that in 2008-09, 31 out of the 41 IMF agreements made with countries in response to the global recession included pro-cyclical fiscal or monetary policy, with 15 having both. This inclination of the IMF has been criticised by several other economists including the Nobel Laureate Joseph Stiglitz, who criticised the IMF’s handling of the East Asian Crisis in the following terms: “All the IMF did was make East Asia’s recessions deeper, longer, and harder”. Slashing the development budget in Pakistan so that the deficit could be reduced, even when the Pakistani economy was battered by the 2010 floods, was consistent with the IMF’s general policy but countered Pakistan’s own development needs.

The IMF’s insistence that government deficits cause inflation is both theoretically and empirically disputed in academic circles. The reality is far more complex; inflation comes from various sources including escalating global commodity prices, currency devaluation, wage-price spirals and low productivity, issues that would not be solved merely by cutting the deficit. This does not mean that inflation is not a serious issue in Pakistan. On the contrary, it presents a huge burden for the common man, but this is more because of stagnant wages due to the absence of industrialisation than due to the deficit. It is worth noting that countries such as Japan, South Korea and Brazil grew rapidly with higher inflation than Pakistan did. This was made socially and politically sustainable because real wages were rising too. In Pakistan, another IMF favourite — slashing subsidies on basic commodities — only serves to enhance the pain inflicted by inflation rather than leading to any competitiveness.

Ironically, even if we were to make deficit reduction our primary goal, over and above any developmental goals that we may have, the IMF dictated policies are unlikely to achieve even that. This is due to the fact that the nature of cuts the IMF advocates stifle prospects for long-term growth by retarding development. The IMF’s policy towards Public Sector Enterprises (PSE) is a case in point. The policy is to privatise PSEs and use the proceeds to repay debt and prevent the PSEs from being a further drain on the exchequer. This view continues to hold despite the fact that competing countries have created national champions out of their PSEs. Rather than driving them into the ground, they have used them to develop valuable capabilities and develop key sectors.

Countries that started behind Pakistan and have since overtaken it, developed their human capital by investing in crucial areas including, health and education. The IMF, on the other hand, advocates privatisation of these while insisting on the most unproductive expenditure of all: domestic and external debt service. According to the Ministry of Finance, Pakistan’s debt service alone made up nearly 30 per cent of the current expenditure in FY 2011-12. That is over 1.5 times the development expenditure for the same period. Also ignored are the effects of other IMF-backed policies on the fiscal deficit; an influential study by John Toye (2000) shows that trade and financial liberalisation reforms can lead to a six to seven per cent increase in the deficit.

A pro-cyclical macroeconomic policy that is not coherently tied to development aims is likely to make the debt situation worse by retarding economic growth. European policymakers are increasingly realising the futility of pursuing fiscal austerity in order to reduce the debt burden. Pakistani policymakers, too, would do well to consider different policy options; as long as the IMF continues to prioritise creditors over the interests of the country as a whole, growth will not only remain low, but the debt burden will continue to be unsustainable.

Published in The Express Tribune, August 27^th, 2012.

Correction: Due to an editing error, CEPR was incorrectly reported to be London-based in an earlier version of the article. The error is regretted.