IMF champions growth

But calls for more cuts

26 June 2013

As global economic risks and stagnation in major economies are expected to persist, the IMF’s rhetoric is increasingly anti-austerity, reflecting changing national priorities in the US, Japan and France. However, where IMF policy influence is greatest, spending cuts continue.

At the April IMF spring meetings the communiqué of the committee of finance ministers that oversees the Fund’s work confirmed the change in emphasis. The need to manage public debt and contain the risks of instability was relegated to a “medium term” priority. The “urgent” task for global policy makers was decisively (and repeatedly) stated to be jobs and growth.

An April staff discussion note co-authored by Fund chief economist Olivier Blanchard reveals a more orthodox view that to “control debt” requires “medium-term consolidation” alongside mechanisms to respond to any shocks to economic growth that could “derail implementation” but it emphasises that “weaker private demand … should call for slower fiscal consolidation”. The IMF’s April World Economic Outlook (WEO) report found that “fears about high inflation should not prevent … highly accommodative monetary policy”, calling it the “dog that didn’t bark”. Notably, the conclusion of the WEO is not counter to longstanding IMF policy positions; the report argues that the crucial factor in ensuring inflation threats remain contained is a continued commitment to central bank independence.

Changed approach?

A March working paper from the Initiative for Policy Dialogue (IPD) at Columbia University and the South Centre, an intergovernmental developing country think tank, challenges whether this rhetorical shift has any substance. Using the October 2012 WEO database, the paper finds that 119 countries are contracting public expenditures in terms of GDP in 2013, affecting 5.8 billion people. Consolidation is most severe in developing countries with nearly one quarter of them expected to cut expenditures below pre-crisis levels.

The paper reviewed policy discussions contained in 314 IMF country reports (including Article IV consultations and program reviews) relating to 174 countries between January 2010 and February 2013. The analysis shows that 100 countries planned to remove subsidies to food, fuel and agriculture, 98 countries planned wage cuts, 80 countries intend to reduce social safety nets, 27 countries plan cuts to pension and health care entitlements and 30 countries aim to increase labour flexibilisation; in addition 94 countries plan tax increases (such as value added and and consumption taxes) on basic goods and services. The report points to the IMF’s “role in influencing policy” in both borrowing and non-borrowing countries, as “a main contributing factor” in the “drive to slash budgets in developing countries”.

No reverse gear in the eurozone

Advanced economies, in particular across Europe, are also subject to pressure for more cuts from the IMF. Eurozone ministers agreed in April to extend the period in which Portugal can repay loans from its European partners by seven years, but only if it maintains its commitment to cuts in sectors including healthcare, social security and education. After Portugal’s constitutional court ruled in April that cuts specifically targeting civil servants were unconstitutional, creating a €1.3 billion ($1.7 billion) shortfall, prime minister Pedro Passos Coelho promised to cover the shortfall with further cuts, proposing reduced funding for schools as one possible response. The Troika (the coalition of euro area lenders comprising the IMF, the European Central Bank and European Commission) announced that new decisions on Portugal would wait until further clarification. Popular protest against the plan have continued, including rallies in April organised by the country’s largest union. Unemployment grew to 16.9 per cent in the last quarter of 2012 amid a 3.2 per cent economic contraction during 2012.

Portugal has been lauded by the Troika for successful deficit reduction, but in a June statement following approval of the latest financing tranche the Troika sounded a note of caution: ; “The solid social and political consensus that to date has buttressed strong programme implementation has weakened significantly,” which meant “the scope for more financing was limited.” Nevertheless IMF negotiating team lead Abebe Aemro Selassie reiterated that “we don’t see the need to consider a radical change in programme design at this stage”. The budget deficit actually rose in 2012 despite extensive cuts and the IMF now predicts public debt to rise to 124 per cent of GDP in 2013. Despite its delayed deadline for managing the deficit, Portugal’s government has not altered its commitment to save €4 billion in public spending in the next three years. Portuguese economist Nuno Teles reflected in June “does this mean the end of austerity? No … the current government … seeks to gain time to continue to implement its programmewhile proclaiming victories against windmills”.

In Ireland in June, the Troika agreed to permit a delay of so-called ‘stress-tests’ of Irish banks until 2014 despite concerns over the viability of the Irish banking sector. The Irish finance minister Michael Noonan indicated that the lenders had also agreed not to make Ireland “a special case with more onerous conditions” in case it does require additional financing to defend against “extraneous events”. Nevertheless the programme conditions have remained unchanged, though the government has struggled to implement a Troika requirement to cut public pay, after rejection from public sector workers in April.

Cornel Ban of Boston University contrasted the apparent prioritisation of jobs and growth while the Fund continues to praise “frontloading of consolidation to orchestrate … attacks against the state”, citing Bulgaria, Romania, Hungary, Portugal, Lithuania and Estonia. Ban describes it as “the reassertion of fiscal orthodoxy”., including via Fund disapproval of “the adoption of higher taxes at the top in high-income states”. He concludes that the “institutions seems stuck in a tense hesitation towards embracing a more expansionary and resolutely less inequality-reinforcing fiscal policy stance”

In current programme countries outside Europe the practice, rather than rhetoric, of IMF policies also points to austerity. In Malawi, a May IMF report found that it is “critical” that Malawi places “weight” and “emphasis” on continuing tight economic policies that prioritise curbing inflation, and reflect the need for “fiscal restraint to contain aggregate demand”. Any “policy reversals would jeopardise the prospects for recovery and sustained growth”. The IMF recognised “growing public complaints and protests” but noted that the “authorities reiterated their commitment to stay the course of policy reforms to the managing director” during her visit in April.

Jobs & growth priority?

An IMF policy paper on jobs and growth (see Update 86) argued “structural reforms to enhance competitiveness gains in Southern euro area countries where demand is weak are needed to rebalance growth within the monetary union”. In late June the Fund praised Spain in its annual assessment for its deregulation of labour markets and reductions in fiscal deficits despite recession, saying “key imbalances are correcting rapidly” but insisting that “labour reform needs to go further” and “deeper reforms of collective bargaining may be needed”. Earlier that month Dani Rodrik of Harvard University derided the supposed reversal against austerity as “old wine in a new bottle”. He pointed out that “the prevailing approach – targeting debt through fiscal austerity and competitiveness through structural reform – has produced unemployment levels that threaten social and political stability.”

An April workshop at Boston University analysed whether the “crisis really changed the [Fund’s] advice” and found that though changes have occurred, these remain “too modest to suggest that an economic paradigm change is imminent”. According to co-organiser Cornel Ban, the workshop found that the Fund has narrowed its agenda to “orthodox economic policy” and “continued to make counter-cyclical policies conditional on bond market sentiment” as well as “contribute to the weakening of recovery via continued discrimination in favour of foreign creditors”.