Originally Publised in THE FINANCIAL TIMES

THURSDAY MARCH 5, 1998



Trying to do too much



"In Asia, the International Monetary Fund has ambitions which are incompatible with its real role and which interfere with nations' sovereignty."

In the past 20 years, South Korea has pulled itself up from poverty to become a major industrial nation with a per capita income of more than $10,000 (6,000) by a combination of thrift, education and hard work.

The economy enjoyed economic growth of 8 per cent a year from 1990 until the beginning of the recent economic crisis, the same remarkably high rate of growth that it experienced in the 1980s. Before the crisis began, the inflation rate was less than 5 per cent and the unemployment rate was below 3 per cent. Quite an impressive achievement.

Indonesia, although much poorer, has also enjoyed an impressive 7 per cent annual rate of economic growth in the 30 years since General Suharto came to power, causing Indonesia's per capita income to increase more than fourfold. Similarly positive performances were achieved by Thailand and Malaysia.

These economies were rightly the envy of the world. The economic crises that hit Asia last summer were not caused by a sudden shift in their fundamental conditions or in their basic policies. They got into trouble because of circumstances that could have been cured by a combination of standard macroeconomic adjustments and a temporary restructuring of foreign bank loans.

The basic problem in Thailand, Indonesia and Malaysia was unsustainably large current account deficits, causing the accumulation of large short-term liabilities to foreign creditors. These large current account deficits were due in part to their inappropriate policy of fixing their exchange rates relative to the dollar. That policy became even more damaging when the decline in Japanese interest rates caused the yen to drop sharply, making the products of these countries in the Association of South East Asian Nations even less competitive.

Korea's situation was different. Although Korea experienced a temporary jump in its current account deficit in 1996 because of the collapse of the world semiconductor market, Korea did not have a chronic current account problem or a fixed exchange rate between the Korean won and the dollar.

Korea got into trouble because its banks and finance companies had borrowed too much in foreign currencies with short-term maturities, thereby accumulating much more short-term foreign debt than Korea had reserves. The general troubles in Asian financial markets caused investors around the world to focus on that imbalance and to seek to take their own funds out and repay their loans before Korea exhausted its reserves.

Thailand, Indonesia and Malaysia needed to end the policy of fixed exchange rates and to shrink their current account deficits. Korea was already heading toward a current account surplus by last summer and really only needed a temporary restructuring of its foreign bank loans to give the Koreans time to accumulate the reserves needed to service their debts.

Unfortunately, the International Monetary Fund seized the troubles in the region as an opportunity to insist on fundamental structural reforms. By asserting that these economies were basically unsound and needed to remake their financial systems, tax and tariff structures, labour markets, central banking procedures and corporate governance, the IMF inappropriately frightened investors and lenders.

That is not to say Korea would not benefit from improving its labour laws, or that General Suharto has not been extracting substantial bounties for his family and his political supporters, or that the banking systems in all of these countries are not weak by US and European standards.

But those problems had existed for a long time with out hurting economic growth or preventing these countries from borrowing in the global capital market. Correcting those weaknesses was not necessary to deal with the problems that unfolded last summer. Attempting to force such fundamental reforms was both counterproductive and inappropriate for the IMF.

The IMF's long lists of fundamental reforms might, if implemented, help these countries in the long run. But past experience is a reminder of the fallibility of economic advice. More importantly, the IMF should not be usurping the legitimate role of sovereign governments. The IMF should only insist on policies that are needed to restore a country's access to international financial markets.

The massive but unwieldy financing packages totalling more than $100bn that the IMF proposed for Korea, Thailand and Indonesia were also inappropriate. If their purpose was to act as a lender of last resort in order to stop the financial panic and the runs by creditors, the IMF's funds would have had to be available for immediate disbursal, not held back until these countries demonstrated their willingness to carry out major structural reforms.

Conditionality based on fundamental reforms is incompatible with the role of a lender of last resort. Equally important, using IMF funds to pay off loans to private creditors weakens the incentive of lenders to be cautious in future international lending.

The inappropriateness of the IMF's interference with national sovereignty and the excessive size of its lending facilities are quite separate from the question of whether the specific short-term macroeconomic policies imposed by the Fund - like the 20 per cent real interest rates and the contractionary budget policies required of the Korean government - are correct. My judgement is that they are not and that their imposition makes the current situation unnecessarily painful. The fact that some of the local government officials express support for the IMF programs is neither surprising nor a good guide to their true feelings.

There is a role for the IMF to play in advising countries and in acting as an honest broker between creditors and debtors when problems arise. There is a serious danger that by seeking a far grander role in reshaping these economies, the IMF will lose its legitimacy and effectiveness.


Martin Feldstein is professor of economics at Harvard University and president of the National Bureau of Economic Research. He is the author of "Refocusing the IMF" in the March-April 1998 issue of Foreign Affairs