The role that the IMF played leading up to the Greek crisis is drawing criticism from leading economists. The IMF seems to be ignoring the advice of its own macroeconomic research group for political reasons. This particular case of politics trumping economic rationale should be an eye-opener for us, when it comes to following IMF-generated advice.
The IMF has, arguably, the strongest group of macroeconomic policy researchers in the world, and their advice from the start has been that the so called ‘expansionary austerity’ imposed on Greece would not work. Chief Economist Olivier Blanchard, who will soon be retiring, came out against the low-inflation policy as early as 2010 when he argued that the inflation target should be raised to four per cent. The “IMF World Economic Outlook”, published the same year, refuted the notion of “expansionary austerity”. After that, in numerous research papers, IMF economists kept arguing that ‘expansionary austerity’ would make matters worse. Given this advice, one would have expected the IMF to part ways with the European Central Bank (ECB) and the European Commission (EC). Instead, it seems to be standing firmly with them in pushing the repeatedly discredited notion of ‘expansionary austerity’.
As stated above, it seems that politics often trumps economics in the IMF’s policy recommendations. Irrespective of what the Fund’s own economists are saying, the IMF is going to push the same failed policies for its own political reasons. And that should worry us more than anything else when it comes to learning lessons from the Greek crisis. The key lesson for us is not in what Greece did or did not do, but in how the IMF acted. It has been around far longer than the ECB and the EC and has seen numerous crises arising out of public sector excesses. One does not need to go even that far back in time to see that. The straitjacket of ‘expansionary austerity’ did not work after the Asian financial crisis. The only country that did well after the crisis is Malaysia, and it is important to note that it paid no heed to IMF advice.
The IMF has been advising Pakistan to buy dollars from the spot market to increase its dollar reserves. This will push the value of the rupee further down. The rationale given is that a depreciated currency will encourage exports. It is more likely that the impact of falling global commodity prices and power shortages is much larger on our exports than any recent appreciation in the rupee, which is going to be short term anyway. Building reserves by buying dollars from the spot market does more to reassure the IMF that it will get its money back. This move may have a negative impact on the GDP by increasing our import bill as our key imports are inflexible.
Ultimately, we need to remember that in a debt contract, the interests of the lender and the borrower are not properly aligned. Just like any other lender, it is in the IMF’s interest to give advice that protects its interests, even if it is at the expense of the growth prospects of the borrower. According to Nobel Prize winning economist Robert Shiller, countries should borrow money not by issuing debt, but by issuing GDP shares that pay a fraction of nominal GDP to the lender. If the IMF lends money through GDP shares, known as trills, then it will get more money back if the GDP goes up. If the GDP goes down, it will get less money back. Hence, the interests of the IMF and the borrowing country would be aligned with instruments such as Robert Shiller’s trills.
Trills could also prevent the endless blame game that we see in every crisis. In the case of Greece, lenders blame the Greek government for irresponsible borrowing. One can easily blame the lenders too. Excessive loans should not be advanced to profligate governments. The Greek crisis was created as much by irresponsible lending as by irresponsible borrowing. With trills, lenders would only provide funding when they can see a direct impact on growth, so they will act more responsibly.
Until countries start borrowing by issuing trills, and the IMF and other lenders start lending by purchasing trills, we must tread very carefully when it comes to following IMF advice. Perhaps, the single-most important lesson from the Greek crisis is this: the IMF is subject to political pressures, and potentially gives self-serving recommendations.
Published in The Express Tribune, July 23rd, 2015.