The International Monetary Fund was created to, among other things, help finance the trade deficits of bankrupt countries. So readers will be amused to hear that the IMF itself is currently in financial straits. It has decided to freeze staff wages in real terms in the medium term, and outsource some back-office operations to low-income countries. This will reduce its real spending by 1% per year.
Even after that, the IMF is projected to run a deficit of SDR 142 million in 2007-08 and SDR 206 million in 2008-09. These deficits will comfortably be covered by the IMF’s reserves. Yet it seems ironic that the institution that has long lectured developing countries on deficits is now heading for deficits itself.
Why so? The IMF has traditionally financed its operations from interest earnings on loans to countries. But it charges poor countries only 0.5% interest, insufficient to finance lending operations. Its main income comes from loans to middle-income countries at quasi-commercial rates. But such countries (notably those in South America and Eastern Europe) have in recent years ceased to suffer repeated crises, or to borrow. Brazil and Argentina have prepaid old IMF loans. Russia, once in constant trouble, now has massive trade surpluses.
The biggest trade deficit in the world—a massive $ 700 billion—is run by the USA, which can print dollars and so needs no IMF help. Most other countries are running surpluses. So today the IMF lends mainly to some small developing countries.
Does this signify failure? Not necessarily. The IMF’s job is to create a world without crisis, so it can (and has) claimed that its very success in reducing crises has reduced its income too.
This claim has some truth but is wildly exaggerated. Yes, once wayward countries in South America have indeed embraced fiscal prudence, though it remains unclear to what extent the IMF is responsible. One major reason for the current underemployment of the IMF is a booming world economy where the USA trade deficit provides such a flood of dollars that the IMF is not needed to provide more. The second reason is heady rise of global capital markets, which have shrunk the IMF’s relevance.
When the IMF was created after World War II, the dollar was the only convertible currency. Global capital markets did not exist, and had to be slowly and painstakingly created. The biggest borrowers from the IMF were rich countries. Bank of England Governor Mervyn King points out that Britain had four IMF loans and two devaluations between 1946 and 1971, although its current account deficit never exceeded 1% of GDP. The capital markets at the time could not plug even such a modest gap. But since 1998 Britain’s deficit has always exceed 1.8% of GDP, yet capital markets cover that easily.
Strong capital markets have made IMF loans to rich countries obsolete. New Zealand’s current account deficit since 1990 has averaged over 3.7%, a big gap, but capital markets have covered that large gap. We live in a brave new world where global investors are willing to hold bonds of all countries, even developing countries that were once considered much too risky.
The IMF was created to provide a governmental solution (all IMF shareholders are governments) to a major market failure (lack of capital markets). Now that capital markets have bloomed, is the IMF irrelevant?
To some extent, but certainly not entirely. Financial crises will undoubtedly occur in years ahead, and the world will need a lender of last resort (who also tries to pre-empt crises). But clearly the IMF must cut spending sharply, since it will be lending mainly to poor countries at 0.5% interest.
I would suggest two cost-cutting steps. First, move the IMF headquarters to Delhi, Bangkok or some other third world country where living costs are half or less than US costs.
Second, outsource much IMF work—not just back-office stuff but some economic analysis too—to local third world economists at local wages, rather than at astronomical expatriate wages. When most countries are not borrowing and may never borrow, why spend expensive manpower on voluminous reports and consultations of diminishing relevance?
When I suggested this at a press meeting with the IMF Managing Director, he replied that some things cannot be outsourced. For instance, he said, countries do not outsource their embassies.
He should look at the US Embassy, which outsources a vast array of jobs (economic information, consular) to local Indian staff. He should look at the World Bank which increasingly uses local Indian staff. Finally, he should recall the words of John Maynard Keynes, one of the founders of the IMF. Keynes said the IMF should not be in Washington DC, since that would put it under too much US Treasury pressure. Why not escape to Delhi or Bangkok?