IMF advice paradox

increase social spending, but contain deficits

23 September 2009

By Nuria Molina, Eurodad

During the last year, the IMF has embarked on a public relations offensive to prove that it has changed its traditionally austere policies. However, recent research in Latvia, El Salvador and Ethiopia shows that the Fund may not be practising what it preaches. At the end of 2008, Olivier Blanchard – IMF’s Economic Counsellor – said: “If no fiscal stimulus is implemented, then demand may continue to fall… I would put it even more starkly. What is needed is not only a fiscal stimulus now but a commitment by governments that they will follow whatever policies it takes to avoid a repeat of a Great Depression scenario.”

The IMF has called for fiscal stimulus and recognised that developing countries dependent on a single export, less diversified economies, and those strongly reliant on foreign capital have been particularly vulnerable in the current crisis.

Forthcoming research by NGOs Eurodad, Solidar and the Global Network assesses three IMF programmes in El Salvador, Ethiopia and Latvia, revealing that the Fund is now allowing countries to incur slightly higher deficits compared to historic IMF positions. As always, the devil is in the detail, and the very limited resources available in these countries has effectively constrained the opportunities these governments have to adopt more decisive counter-cyclical monetary and fiscal policies.

For highly indebted countries like El Salvador, counter-cyclical fiscal policies need to be accompanied by greater domestic resource mobilisation. However, the IMF continues to focus on their traditional tax advice including improving administration, auditing, and collection procedures – which, though important, fail to address crucial tax reform proposals suggested by civil society groups. Nelson Fuentes from El Salvadorian NGO FUNDE said that “curtailing tax evasion by 50 per cent could generate $200 million per year. A reform of income tax, rather than VAT hikes, would generate new available resources. The government, private sector and international institutions should agree on a more progressive tax structure.”

In Latvia, the IMF has supported the implementation of more progressive taxation. However, much more remains to be done to set up progressive taxes and combat tax evasion.

The report also finds that while the IMF is consistently supporting increased social spending, the budget cuts it requires make increased social spending and anti-crisis programmes difficult to achieve. At best, social spending is only maintained (Ethiopia) and in some cases (Latvia) is actually cut. A government official from El Salvador explained that “the Fund is not opposed in itself to the fact that we are prioritising this type of [social] spending. But the Fund sees things in terms of deficits and this is where they are coming from when negotiating with you. This is a problem as it does not give you a chance to explain that specific projects not only help revitalise the economy but also include a social and productive dimension.”

Ignoring equitable growth

In all three cases, the IMF programmes prioritised financial stability priorities over growth in productive sectors of the economy and job creation. Policy priorities and goals related to the real economy, or productive sector – such as targets for achieving higher GDP growth, increasing productive investment, increasing employment and diversifying the economy – were non-existent. Although El Salvador and Latvia attempted small stimulus efforts, these were constrained by the priority goals of stabilising the financial sector and getting external creditors repaid.

More worrying is the IMF programme limitation on sustaining expansionary policies over time. Although the programmes allow the governments in Ethiopia and Latvia to have higher deficits, these measures are narrow and temporary, as the IMF expects the countries to bring down their deficits to pre-crisis levels as soon as 2011. The IMF seems to be strictly focused on balancing government income and expenditure and rebuilding the foreign reserve buffers.

A strict focus on balancing the budgets may help the country stabilise their economies, but undermine their prospects for equitable growth. Policy measures such as investing in social programmes and education; targeted credit to small and medium enterprises; and capital controls to reduce the volatility of the financial sector could all help secure stability and growth at the same time. However, these types of policies do not seem to be on the table for discussion.

A crucial problem in all countries assessed is the lack of involvement of line ministries, parliamentarians, trade unions and civil society during the negotiations of the IMF loans and the respective budget laws or structural reforms associated with the Fund’s finance. The lack of genuine policy alternatives and more decisive countercyclical measures seems to be the result of a combination of IMF narrow-mindedness on broad macroeconomic objectives, a certain degree of blindness towards the broader development strategy of the government, and the finance ministries’ own desires to keep the budgets balanced.

In a recent briefing, IMF representatives expressed their hopes that in 2011 the world would experience a resumption of the “healthy growth of the last decade”. However, the crisis has shown that previous economic growth had rotten foundations. The question is whether international institutions such as the IMF, and national governments will learn the lessons from this crisis and start building the recovery on a more solid basis.