How IMF Reform Makes It More Efficient at Rescuing Countries with Massive Debt

4345 words (17 pages) Essay in Politics

18/05/20 Politics Reference this

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The International Monetary Fund (IMF) was formulated in 1945 after the second world war. The original goal of the IMF as at the time of its establishment was to assist economic crisis, that is, assist nations suffering from financial crisis so as to prevent the domino effect such crisis would bring about because states depend on one another, and if the economy of one nation is left to fail then it will have a ripple effect on many other nations. The IMF consists of 189 members, these members are tied together by fixed exchange rates and the role of the IMF is to oversee and administer these fixed exchange rates and ensure that its members keep to their commitments. However, in recent times the role of the IMF has advanced, the IMF still assists financially troubled economies but due to the changing state of financial and economic trends the IMF also has the role of ensuring that they are in line with these economic trends so that the organization can function smoothly. The IMF assists countries in financial crisis to develop their economic program. If the economy of a nation suffers, they go to the IMF for assistance or the IMF intervenes, depending on the severity of the situation. The IMF has not seemed to achieve its goal however. This is because in a lot of countries which have a history of lending money from the IMF, these countries tend to have a history of protest against the IMF intervention. Some examples being, Greece, Portugal, and Ireland. The reason for these protests is that the Monetary Fund seems to leave citizens worse off through the implementation of polices it puts in place to ensure that the borrowing country is able to pay the loans back. These policies tend to raise the cost of living and an individual’s spending power is depreciated. Along with this challenge faced by the IMF, there are a lot more. In this paper, I will be discussing the problems faced by the IMF, reform attempts made to sort out these issues, and an appropriate global governance solution. I will go on to discuss the issues with global governance and some options we have for dealing with these problems. The existence of issues with the IMF proves to us that a global governance solution is needed. In this paper, my focus is to show that the IMF needs to undergo reform to the structure of its funding system and should focus less on short term funding but more on long term funding, as well as using all of their available resources to provide top quality research and advice to these nations in massive debt. This is the global governance solution I propose; the structure of the IMF organization need take on a huge reform which is negotiated and agreed upon by all 189 member states.

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As mentioned in the previous paragraph, there are 189 participating countries in the IMF. These states include all states except seven, which are Cuba, Andorra, Liechtenstein, Monaco, North Korea, and Poland. Member states of the IMF have realized its ineffectiveness and are pushing for reform. A number of reform attempts have been made, but before we look at these reform attempts it is best to go in-depth on its global governance attempts so that we can better understand why exactly the IMF is ineffective.  So, looking into the IMF’s global governance attempts, we have the intervention in Asia in 1997/8 and the IMF intervention in the Global Financial Crisis (GFC) in 2008.

The collapse of the Asian economies was one of the great economic surprises of the last half century. This is because the Asian financial crisis came not long after Asia was touted as the ‘economic tigers’ .  The Asian economy was experiencing a boom in which most of its countries Gross National Product expanded by six to ten percent annually from 1985 to 1995 (Levinson, 1998). This economic boom led to excessive spending and huge infusions of foreign capital in the Asian economies and this caused for the economic crises. The IMF encouraged the flow of foreign capital but did not strengthen bank supervision to help control it and this led to an outflow of twelve billion US dollars which ended up bringing down currencies and whole economies in the process.

The IMF was called upon in hopes to curb this economic depreciation. They provided financial support to three of the countries affected most by the crisis, Indonesia, Korea, and Thailand. The IMF provided about 35 billion US dollars to help these Asian countries get back on their feet. Along with this, they implemented internal macroeconomic policies on these countries such as the tightening of monetary policy so as to hamper the collapse of the countries’ exchange rates and also to prevent the depreciation of their currency and causing inflation. Steps were also taken to ensure that the problems of the financial and corporate sectors were resolved or at least addressed. Given the nature of the cause of the crisis, emphasis was put more on the structural reforms than on financing or implementation of macroeconomic policies. These efforts put in by the IMF to solve the financial crisis however did not work out as they expected although they did still assist in cushioning the shock of the financial crisis.

Going on to look at the Global Financial Crisis (GFC) of 2008, this crisis began due to investors in the U.S and abroad who were in search of a low risk high return investment. They started investing in the U.S housing market because at the time they were viewed as smart and easy ways to make enormous interests of investments. They believed they could get a better return from the interest rates homeowners paid on mortgages, than they could by investing in treasury bonds. Lenders promoted these forms of investments along with insurance companies. Both high- and low-income earners were encouraged to invest and were granted access to the mortgage securities being provided. The way these mortgage securities were set up, it seemed as though the banks could not lose even if the lenders are not able to keep up with their payments because they will just end up taking back the houses. The prices for houses kept rising however and eventually lenders were not able to keep up with their payments. This caused for an increased supply of houses with little demand for houses, so house prices started collapsing. A lot of big lenders could not get their money back and eventually had to file for bankruptcy, but they were bailed out by finance programs. This mishap affected the whole financial sector and till today we are still feeling effects of this financial collapse.  The IMF intervened and were the principal international organisation to fortify the global financial system. They contributed significantly to restoring confidence in the world financial system. The IMF has been actively involved in the lending process of the affected countries. They actively helped in the shaping of the global policy and contributed to the process of global financial system modernization (Owusu-Kodua, 2013). The IMF introduced lending tools such as the ‘Flexible Credit Line’ to help support affected countries. The fund provided loans to various countries some being, Mexico, Greece, Poland, France, and Thailand. In such perilous times, the IMF helped governments in maintaining and also increasing social spending. The IMF supported measures which promoted the increase of spending on social protection programs to moderate the impact of the crisis on vulnerable sectors of the society (Owusu-Kodua, 2013). The IMF was successful in restoring some order into the financial sector of the world.

These are some global governance attempts that have been carried out by the IMF but these attempts although partially successful do not exonerate the IMF completely from the problems which the organization poses. In this paragraph, I will be looking at the problems of the IMF and I will expand on why although they have helped cushion economies during times of financial hardships, their policies are the mostly the cause of these financial hardships.

The first problem I will be looking at is the tough conditions implemented by the IMF on its borrowing countries in order to grant them loans. When it comes time for the IMF to grant loans, the organization puts forward certain conditions for the lenders to uphold in order to be granted these loans. These conditions usually require borrowers to apply restrictive monetary and fiscal policies in order to reduce their debts. These restrictive macroeconomic policies have only resulted in high interest rates and reduction in consumer purchasing power and business credit, which have only in turn led to economic recession, low investment, and unemployment (Mikesell, 2000). Critics have charged the IMF with prescribing the wrong medicine to countries in crisis (Sachs, 1997). Conditions placed on these loans are viewed as too intrusive and affect the economic and political sovereignty of these borrowing countries. These conditions are always too intense and usually always lead to domestic opposition (Mikesell, 2000). The IMF fail to use their resources to ensure that the production and investment levels of their borrowing countries are maintained. The poor suffer the most from these conditional loans granted by the organization. So, the IMF needs to take steps to correct these conditional policies which they must implement in order to grant loans.

Another problem of the IMF is that it imposes policies without really understanding the system of these countries they lend to. This causes for inefficient policies to be implemented in these countries by the IMF due to the lack of adequate research on the nature of the countries they loan to and this is why they (IMF) are always in shock when their policies leave countries which they’ve intended to help, worse off. Critics view the IMF as having a ‘one size fits all policy’ which focuses on economic models with unrealistic assumptions of what actually goes on in the real world. They impose policies with little or no guidance from these affected countries. The policies which they impose have detrimental effects on the economies of these borrowing countries. The organization focuses on short term crisis management and this is too costly as it does not really solve the problems of these borrowing economies in massive debt. A better fix to this problem would be to focus on improving the financial structures of these countries. Lending money to economies with weak financial structures will only increase the debt of these countries in the long run. We can see from previous IMF global governance attempts that the economies which they have tried to rescue from financial crisis have only become worse off today. Some examples of these countries are Argentina and Greece. The IMF does not focus on the internal structures of countries, i.e., financial and political institutions, and this really affects the poor, but more importantly, this lack of focus on internal structures of states leave them wallowing in debt. If the IMF did better research into these organizations and focused on maintaining production and investment, then the policies they impose might have a better chance at working.

There is also the issue of the world bank and IMF performing the same functions. The IMF was created to provide balance of payments assistance while the world bank was created to provide long term loans for financing special projects (Mikesell, 2000). The IMF and world bank, however, have been making general purpose loans for similar roles. The IMF provides structural adjustment loans while the world bank provides loans to finance broad economic and social programs (Mikesell, 2000). These loans are viewed by critics as providing the same functions and these critics suggest that both these organizations should be merged. The fact that both these organizations, the IMF and world bank, provide loans for similar functions causes difficulties for countries because these countries that borrow money from both of these organizations might have to fulfill various differing conditions just to acquire similar loans.

All of these problems of the IMF are mostly related to its internal structure, so a solution for all of these problems would all lead back to the reformation of the IMF. These problems however mostly affect developing countries that are trying to escape financial crisis. These problems worsen poor countries and leave countries in massive debt no chance of getting out of these debts anytime soon. And in a globalized world that we are in now in which countries depend on one another, the worsening of one country will lead to the depletion of the economy of another country which relies on the affected country and it will go on that way thereby having a domino effect and affecting all countries. This is the why the IMF exists, to prevent this from happening. But if the IMF as it is cannot help in solving the problems of the world, unless it undergoes the much-needed reform of its structure and policies.

Looking at the problems of global governance, we have to recognize that global governance is the regulation of interdependent relations in the absence of overarching political authority (Committee for Development Policy, 2014). This form of governance involves numerous actors. The large number of actors is what leads to the first problem I will discuss. The challenge of coordinating activities of a very large number of international actors is one major issue of global governance. To be effective, these organizations need to come together to help solve various global issues such as nuclear war and climate change but these various organizations each have their own individual interests driving their cooperation efforts and will always seek to achieve their personal interests regardless of if it conflicts with the interests of other organizations or states and affects the global governance attempt. We can take the composition of the UN security council as an example; years of discussion have not yet led to an agreement to enlarge and add new permanent members to the council. The reason for this inability to enlarge is due to the fact that the five current permanent members are not anxious to share the privilege with other countries and other countries are not willing to see their peers achieve a higher status than them. Also, looking at the IMF, a restructuring of the organization would lead to more developing countries Obtaining greater power and therefore being better for the organization, but the European countries which over represent the IMF refuse to step down. Countries and institutions involved in global governance always tend to choose individual interests over what is best for institutions and this is a major problem for global governance. Global governance is run by states and what is critical for these states is what is best for their countries, they’re not thinking as global citizens (Frechette, 2011).

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Another problem for global governance is that it is highly influenced by the developed countries, e.g. the United States, the European Union, and Japan. This is why the head of the World Bank is always American and the head of the IMF is always European. It has been like this ever since these institutions were conceived and it still remains this way till today. Global governance indeed focuses on rules to ensure cooperation but if we look at who implements these rules, we would notice that a lot of them are drawn from regulations of developed countries especially the US. So, Global governance is viewed by critics and some of these developing countries as a cover for western hegemony. So, with this the question arises of whether global governance is in fact global or just serves according to the interests of developed nations.

The last problem I want to look at is the fragmented and sporadic nature of global governance. Very few things are really done in terms of the provision of global governance, if we look at previous global governance attempts we would see that although efforts have been made to alleviate these global problems, these efforts made are very far off what exactly is needed to effectively manage these transnational problems. We can see from previous IMF attempts that to cure financial crises especially in developing countries, even though attempts are made, and policies are put in place to rescue these countries at the time of the crisis, these countries end up worse off in the long run. This shows that the time and effort needed by these global governance organisations to provide efficient measures to alleviate global issues is lacking and these organizations just act in the moment, not really planning ahead and anticipating global problems even with all of the resources they have at their disposal to help with this.

The reformation of global governance would lead to better governance practices as we have experienced what our present global governance tactics lack. Although we understand that global governance reform would lead to better global governance practices, we also need to understand that this reform process would not be easy and will occur very slowly due to all of the parties involved all having separate interests. Global governance reform should start from the reformation of internal structures of global institutions. It needs to ensure that global institutions be “representative, effective, and offer opportunities for national and international leaders to develop coalitions for action and reform” (Bradford, Linn, 2007). Strategic guidance, and effective leadership are needed to implement effective reforms that can create a global governance system that is required to tackle global issues. Globalization is always causing for change and global governance needs to implement change along with these changing conditions so as to stay effective and relevant. Global institutions today are fragmented, unrepresentative, ineffective, and also suffer from legitimacy issues (Bradford, Linn, 2007). The organizations at the core of the international system all need to undergo change in order to take global governance away from the traditional system it has been using since its conception. Global governance can be reformed through better participation and representation of non-state actors. The effectiveness and legitimacy issue of global governance could be resolved by a reform of the G8/G20. The G20 provides a solution for global governance legitimacy problems as it represents 90 percent of the word’s Gross Domestic Product, 80 percent of the global trade, and 65 percent of the world population. Its structure encourages for the participation of developing countries in global governance (Bradford, Linn, 2007). It also helps with a better distribution of power and votes of members in global institutions and this helps cure the legitimacy problem faced by global governance.

Previous financial crises have shown that the need for the IMF’s macro surveillance, financial sector advice, and stand by financing are ever so important even more important than funding, as adequate research could help avoid and alleviate financial crisis (Bradford, Linn, 2007).

Also, inclusion of non state actors also helps better the effectiveness of global governance as the power of states is becoming less relevant and individuals are becoming the drivers of globalization. Non state actors should be more involved in global governance as previous global issues have proven to be a strain on states but non state actors like NGO’s which focus on preventing these issues in their respective states could use their research and knowledge to better approach these issues if/when they arise.

In regard to IMF reform assisting countries with massive debt, in 2012, the organization proposed a new institutional view regarding financial liberalization and the control of capital after they came to the realization that unrestricted capital flows could prove to be disadvantageous to developing countries (Gallagher, Ocampo 2013). This new institutional view places an emphasis on the surveillance role of the IMF in today’s political economy. It recognizes the harmful effects associated with unrestricted capital flows, along with the fact that opening up to capital flows is ideal only after a nation has achieved certain levels of financial advancement and institutional development. The IMF also monitors industrialized countries and encourages these countries to pay close attention to the possible negative spillover effects that could be created in developing countries into which capital flows (Gallagher, Ocampo, 2013).

These are efficient steps taken by the IMF to help countries recover from debt, however, there is more that can be done to help countries in these situations of excessive debt. The IMF needs to enforce more stringent rules regarding capital flows rather than leave it in the hands of international players who do not really consider what is best for other parties. Currently, the IMF leaves developing nations, which do not possess the adequate resources and knowledge on issues concerning capital flows, to determine the resilience of their economies in relation to various degrees of capital flow liberalization. A lot of countries in massive debt are developing countries and this is due to the fact that they borrow a lot in hopes of growing their economies, however most of these loans which these countries take on are short term loans and these short term loans are not very useful to these developing nations. These loans might cause for some immediate change but in the long run as we have seen with the likes of Argentina, these loans end up leaving the countries worse off as they have to repay a lot more than they have gained and thereby leaving them with more debt to pay off. The IMF should support more long-term loans as short term loans affect currency volatility and this causes for uncertainty in an economy thereby making it difficult for investors to put their money into the economy of that nation. Long term loans provide benefits that could help out countries in debt, especially developing nations. They can effectively put in place long term strategic goals on how they plan to use these loans, while also having more time to determine potential returns on investments. The IMF should also consider imposing the Tobin tax. This is a type of tax which is placed on foreign exchange transactions. This tax will help in controlling the movement of short-term loans thereby managing debt control. This tax penalizes short term movements of speculative capital by reducing the amount of profits investors stand to gain from these transactions (De Angelis, 2000). It also helps establish greater autonomy for governments of developing nations and these governments can then go on to pursue their own economic policies thereby helping curb assistance from external parties. The Tobin tax also grants governments the potential to increase revenues which can then be put to effective use and drag them out of debt.

In conclusion, the IMF is taking noticeable steps to reform its organizations through the establishment of better policies and better restructuring of the organization in order to rescue countries drowning in debt, but there is still more that can be done by the organization to ensure that countries are better off financially than they currently are. The IMF possesses all the resources it needs to help get countries out of massive debt, and it needs to make full use of its funds and knowledge so that the organization becomes more proactive and more involved in the financial sectors of all global economies. The provision of adequate research would help educate these countries in enormous debt on how to get out of these debts and how best to manage their economies in this changing world of globalization so as to stay out of debt and reduce any chances of exacerbating their current debts.  

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