The IMF: Reform vs Dismantling

The International Monetary Fund (IMF) was originally established with the purpose of promoting stability within a system where the U.S. dollar replaced the Gold Standard following World War II. However, in the 1970s this system was abandoned for a floating currency system and so the IMF was forced to evolve into a new role. Now the IMF conducts research into economic matters, provides policy advice to members and makes loans available to countries with balance of payments difficulties, among other things. This last function has created much tension around the world, with critics claiming the IMF is more bad than good. The IMF is charged with creating ‘moral hazard’ by providing a safety net for investors, acting as the agent of wealthy nations, and placing stringent conditions on nations in crisis which discourages them from seeking help. It is clear that the IMF is not perfect, but it is also important to consider a globalized world where there is no organization to step in when nations experience a financial meltdown.

One of the common criticisms of the IMF is that its role as lender of last resort creates a kind of insurance for investors because the IMF will always be there to step in, and so will encourage higher risk taking. The Asian financial crisis in the late 1990s is one example of the problem of moral hazard as foreign investors were ‘bailed out’ with a total of $118 billion, when countries such as Thailand defaulted on their debt repayments. Whether moral hazard is a real problem is difficult to prove, and certain inconsistencies in the argument have been raised such as the fact that in most cases IMF loans have been repaid in full. While some private creditors may be helped by IMF lending, when we consider the devastating losses that were not incurred by the IMF, it is still not clear that moral hazard was the initial cause of such crises. Moral hazard is an issue but it would be more productive to introduce measures against risk taking, which have previously been proposed in the form of limited lending and penalty rates.

When considering whether the IMF is more good than bad it is sometimes important to consider exactly who it is good for. The IMF has often been accused of acting as agents for wealthy and developed nations, particularly the United States and of trying to apply a one size fits all policy. The IMF is made up of 185 countries who are assigned a quota based on the size of their economy, dictating how much financial contribution they make to the IMF, its voting power, and access to IMF financing. Considering America’s voting power it would seem that the IMF is definitely a good thing for the U.S. economy which relies on open markets and free trade. Whether this is good for developing countries or those receiving IMF loans, is a difficult question to answer, although there are those who praise the IMF for its contribution to improving their nations’ economy. The quota system does appear to favor wealthy nations to the detriment of developing nations. However, the IMF has made recent steps to reform quotas so that they more adequately reflect the global economy. Whether or not one agrees with the reforms it still would seem more appropriate to repair the system than to completely dismantle it.

One important issue that arises when the IMF lends to collapsed nations is the conditions it sets, which generally reflect the economic policies of the wealthy nations that dominate the IMF. The conditions tend to be very strict and often impose on a nation’s sovereignty. This can create a situation where countries facing financial meltdown will refuse to take IMF loans because they do not want to be burdened by overly austere conditions, as happened in Malaysia. Some problems which could easily have been avoided or minimized by short term loans from the IMF will escalate because of a countries refusal to accept help until it is absolutely necessary. If this is the case then the role of lender of last resort really becomes obsolete. Recently it appears that the IMF has recognized this dilemma and is moving to make borrowing easier, by creating more flexibility and streamlining conditions. Again such reforms seem far more constructive in ensuring global financial stability than does having no IMF at all.

It is clear that the IMF has had problems in adjusting to its new role as lender of last resort. There will always be some level of risk that moral hazard will occur when the IMF is there to step in. They will also be open to criticism as long as the quota system does not appropriately represent member nation’s economic standing. Finally, imposing overly strict conditions on a desperate nation will only serve to discourage future nations from seeking help. Considering such problems in the IMF it does seem there is more bad than good. However, these are problems that can and are being addressed and it is important to reflect on the consequences of an economic crisis that occurs when there is no IMF to intervene. When a country collapses and can no longer repay its creditors, without IMF funding there is a strong chance that the economic trouble will follow creditors back to their own nation and a new crisis will develop. We now live in a highly interconnected and globalized economy and one nation’s failure can quickly transfer to its trading partners, as happened in the Asian financial crisis. Therefore, it would seem far more prudent to repair current problems within the IMF than to live in a global economy with no organization to stand in and stop crises from spreading from nation to nation.