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Questioning The IMF Prescription
Dr.Akmal Hussain
Newspaper: Daily Times
Dated: Thursday, November 07, 2002

There is a tendency in Pakistan's official circles to accept the IMF policy prescription without question. Indeed IMF approval of the government's economic policies is regarded as a measure of its economic health. This attitude persists inspite of the fact that after more than a decade of diligent adoption of the IMF policy package Pakistan's economy faces deepening recession, growing poverty and continued vulnerability of the exchange rate. It may be time now to conduct a comprehensive, analytical and empirical study of the feasibility of IMF policy advice in terms of its conceptual basis as well as international empirical evidence.

Such a study is particularly called for in view of the fact that an increasing number of countries in Latin America which had been celebrated as success stories of IMF policy have now entered into a major economic crisis. Consider, Argentina has recently defaulted on its external debt that has induced the deepest economic depression since the 1930s. (The GDP growth rate of Argentina was a disastrous minus 15% last year). Similarly Uruguay, which had long enjoyed a prestigious economic rating faced a banking crisis and had to be bailed out a couple of months ago through U.S. and IMF financial support, and is now once again on the verge of default. Brazil, one of the largest countries in Latin America avoided financial collapse through a $30 billion IMF loan last August, while Paraguay, Ecuador and Colombia are all in serious economic difficulties.

The defence by the IMF bureaucracy of the widespread failure of its stabilization program is the argument that while the policy package was right its implementation was inadequate. Such an argument does not hold: If the conceptual framework within which the IMF conditionalities are constituted is to be credible, then it must address the institutional constraints to implementation on recipient governments before placing the conditionalities. (For an elaboration of this point see my paper: Poverty, Growth and Governance in the book titled: Problems of Governance in South Asia). An illustration of the flaw in the IMF argument is provided by an analogy given by Joseph Stiglitz (Vice President and Chief Economist, World Bank): "When a single car has an accident on the road, one is inclined to blame the driver or his car. When there are dozens of accidents at the same spot however, then the presumption changes. It is likely that something is wrong with the design of the road". Stiglitz goes on to argue that the fact that there have been financial crises in 100 countries in the past 25 years suggests that there are "systematic problems" with the IMF policy package. He further points out that the IMF management would have an "incentive to argue that any apparent failures are the fault not of the policies, but those who implement them ------ these perverse incentives suggest that the policy framework generally, and the policy prescriptions individually, may be maintained longer than the 'evidence' would suggest is reasonable".

What is the stabilization package? What are its weaknesses? And what is the perspective within which Pakistan can evaluate IMF policy advice? The stabilization policies that the IMF seeks to enforce across countries, regardless of their institutions of governance or the specific structure and dynamics of their economies are: Cutting down of government expenditure to reduce budget deficits, controlling inflation rates, tightening the money supply and thereby achieving exchange rate stability. If such policies achieve their aim of establishing stable, market based exchange rates then they would certainly facilitate the international flow of capital, goods and services across international borders. However it is equally certain that such policies are in theory and have proven to be in practice, contractionary. i.e. they constrict aggregate demand, lower domestic investment, reduce GDP growth and increase unemployment. Even in those countries where large foreign portfolio investment does take place through such a prescription, it does not necessarily result in economic stability. The Southeast Asian and Latin American experience has shown that such economies are subject to a sudden economic crisis as private foreign capital gets withdrawn due to speculative fears.

Moreover, recent research (reported in the IMF's own World Economic Outlook) shows that in countries of Latin America which have a high degree of financial market integration with the world but an inadequate export capability, are highly vulnerable to currency collapse and debt crisis. Pakistan is also under IMF advice moving towards increasing financial market integration with the world economy and yet its export capability continues to stagnate. Therefore Pakistan's currency too is vulnerable to exogenous shocks, even as its real economy remains in recession.

The theoretical basis of the IMF's policy prescription is the neo classical postulate that the free market mechanism, both at the global and national levels is the most efficient framework of resource allocation. (The question of the distribution of income, both between countries, as well as within a country, is of course excluded from this formulation). Hence the IMF's stabilization package, which aims at market based exchange rates is accompanied by its broader 'Economic Reform Program', which aims at deregulation, economic liberalization and privatization, to bring resource allocation within the framework of the market. The question is, are markets really free? If they are not, then does the outcome within the framework of demonstrably distorted markets, even approach 'efficiency' let alone social welfare, that the theory claims?

It is perhaps because of such doubts that the world community in the post war period established multi lateral institutions such as the IMF, for cooperative economic action. Indeed the modern theory of collective action is premised on the recognition of market failure. There is equally the recognition of the limitations of government. Therefore markets and governments have to work in tandem, with one providing a check on the other.

In the context of the issue of public intervention in the market let us take the example of contemporary international trade. Neo classical theory would argue that it is in the interests of each country to adopt a policy of free trade. Yet it was precisely their failure to do so that led to the establishment of the World Trade Organization (WTO). It can be argued in fact that the WTO is playing a major role in moving the world towards a freer trade regime. At the same time it is significant that there has been greater success in reducing the tariffs on manufactured goods, (which has helped advanced industrial countries), than in reducing trade barriers on agricultural goods (which constrain exports from the developing countries). Thus the very existence and performance of multi lateral institutions is suggestive of two propositions: (i) Markets as they stand, do not necessarily work towards an efficient outcome. (ii) Public intervention through multi lateral institutions is not always equitable or effective. It is crucial therefore to systematically examine the logic and performance of the IMF, to see whether its advice is suitable for the national goals of development.

In view of the failure of the IMF's stabilization program in a large number of countries, it would be prudent for Pakistan's government to conduct an independent evaluation of whether even at a technical level such policies have worked in the past in Pakistan or are likely to do so in the future. Beyond this there is a need to broaden the aim of development policy. The aim should be not merely to achieve lower budget deficits and exchange rate stability. Nor can the aim of development be seen in terms of overcoming the technical problems for achieving a more efficient resource allocation. The aim should be the development of a more humane society. A society that is characterized by enlightenment, equity, participation in the democratic process, the availability of public services and equal opportunities to all citizens to actualize their creative potential. It is in the context of these national goals that a broad based policy for economic, institutional and social change has to be undertaken. It is in this context that the IMF prescription needs to be evaluated.

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