Originally Published in THE BOSTON GLOBE
Tuesday, April 28, 1998
Tying aid to reform undermines Asian nations' recovery
To IMF: First do no harm
Martin and Kathleen Feldstein
IN THE CONTINUING AFTERMATH OF THE financial crisis in Southeast Asia, people are wondering what went wrong. After decades of strong economic growth in the range of 7 percent a year, this region has experienced collapsing currencies and deepening recessions over the last nine months. In the search for answers, attention should focus not only on the internal management of those economies but also on the role of the International Monetary Fund.
The IMF was set up after World War II to help countries maintain fixed exchange rates under the rules known as the Bretton Woods system. When this system was abandoned and the dollar began to float in value along with other major currencies, this aspect of the IMFs responsibilities came to an end.
The IMF then turned its focus toward helping countries in financial crisis maintain their ability to carry on trade under the new arrangement of floating exchange rates. The IMF advises countries on the adjustments in budget deficits and monetary policies needed to end excessive reliance on foreign capital inflows. It also provides short-term loans that allow countries to maintain liquidity or the capacity to exchange their currency for foreign currencies. These continue to be important functions for which an international agency such as the IMF is well suited.
Much of the criticism of the IMFs role in the Southeast Asian economic collapse has centered on the magnitude of the changes in budget deficits and interest rates that the IMF has required in exchange for its financial assistance. Critics charge that the very high interest rates and sharp tax increases have produced unnecessarily deep recessions in Thailand and Indonesia. Were convinced Korea did not even need this traditional IMF medicine since its problems did not include the kind of national overspending and reliance on sustained inflows of foreign capital that characterized Thailand and Indonesia.
In our view the biggest mistake the IMF has made has been to overstep its traditional functions and to use the crisis in Southeast Asia as an opportunity to impose fundamental structural reforms. In pursuit of this, the IMF has interfered inappropriately in matters that are entirely the purview of sovereign governments, such as requiring the Indonesians to end a system of government subsidies of certain consumer products and requiring the Koreans to change their employment legislation and corporate governance rules. The IMF also met strong resistance in Indonesia when it insisted that the Suharto family and its political supporters withdraw from certain favorable government contracts that it labeled "crony capitalism." Regardless of what we or the IMF technical economists think, shouldnt these issues be left to the Indonesians and Koreans?
In support of its call for fundamental reforms, the IMF declared that the economies of Thailand, Indonesia and Korea were unsound, mismanaged, and corrupt. After hearing these pronouncements, is it any wonder foreign creditors were eager to pull their funds out and were reluctant to sit down to negotiate renewed credits? By overextending its role in this way, the IMF undermined the confidence of the international business community and exacerbated the financial panic.
How should the IMF draw a line between appropriate action and unwarranted interference? There are three constructive roles for the IMF in situations like the one that hit Southeast Asia last summer. First, the IMF can act as a middleman or honest broker between a debtor country and the representatives of its creditors. The IMF can bring parties together to work out arrangements for extending or modifying loans on mutually acceptable terms.
In that context, a second important function of the IMF is to be a lender of last resort. That means extending credit immediately to a country that is in danger of experiencing runs on its currency. Although the IMF announced rescue packages of more than $100 billion for Thailand, Indonesia, and Korea, it did not make these funds available on the immediate basis that would have been required to prevent currency runs by creditors.
Finally, the IMF can advise and monitor budget and interest-rate adjustments based on the circumstances of each country, recognizing more clearly the difference between situations like that in Thailand (which had a very large external deficit based on an overvalued exchange rate) and Korea (where a rapidly disappearing external deficit reflected speculative foreign-currency borrowing by some of the nations financial institutions).
The unnecessary pain experienced by Southeast Asian countries shows the importance of learning from the mistakes of the past year. Countries that try to maintain overvalued exchange rates, as Thailand and Indonesia had done, bring currency crises upon themselves. But overreactions by the IMF can make such crises more painful.
Martin Feldstein, the former chairman of the Council of Economic Advisers, and his wife, Kathleen, also an economist write frequently together on economics.