Not Your Grandfather’s IMF: The emergence of policy space in the wake of global economic crisis?

Ilene Grabel

When things have been so bleak for so long, when yesterday’s mistakes routinely become tomorrow’s blueprints, it is understandable that we fail to recognize change when it begins to unfold. This is certainly true of those of us who for so long have railed against the extension of neo-liberalism across the global South at the hands of the IMF/World Bank, Wall Street, leading governments, neo-liberal reformers in the developing world and the economics profession. Faced with a juggernaut of this sort, surely we can forgive ourselves for failing to recognize, let alone take any hope in, signs of change.

Forgiven, that is, if the stakes weren’t so high. But they are very high—and so we can’t be quite so self-forgiving if in fact our pessimism leads us to discount too readily evidence of aperture that could be exploited to bring about the kind of change in ideas and policies that the developing world so badly needs. This insight should warn us against premature conclusions that nothing has or can change.

In this spirit, I argue that the chaotic response to the current global crisis by the IMF and national governments represents a historical moment of “productive incoherence” that has displaced the constraining “neoliberal coherence” of the past several decades. By productive incoherence I refer to the proliferation of responses to the crisis by national governments and multilateral institutions that, to date, have not congealed into any sort of consistent strategy or regime.  For those like this author who have worried about neo-liberalism as a straightjacket over policy space in developing countries, the new incoherence may signal the tentative beginning of the end of an unwise and unjust regime.  Why, then, would we want to prejudge the historical moment as one of continuity rather than potential rupture?

What is the evidence for this new incoherence?

Last week, key economists at the IMF released two studies that provide an important window into the ways that the crisis is causing mainstream economists to rethink their widely held beliefs. In Rethinking macroeconomic policy,” Blanchard, Dell’Ariccia and Mauro argue that central banks should adjust upwards the acceptable target for inflation, from the 2% that has been in vogue during much of the neo-liberal era to 4%. While we’d like to see the Fund’s economists go much further and renounce inflation targeting altogether (or at least recognize that even a 4% rate is far too low in developing countries), we must not overlook the significance of this finding.  By doubling the acceptable rate of inflation based on current experiences, the Fund’s economists have begun to validate earlier work by progressive academic economists (e.g., Gerald Epstein and Erinc Yeldan) and civil society organizations that have been battling the Fund for a long time over its strident and damaging inflation targets.

The second study, “Capital inflows: The role of controls” by a team of IMF economists, is more notable to progressives. It demonstrates that the Fund is continuing the admittedly slow and uneven process, begun after the Asian financial crisis of 1997-98, of wrestling with the issue of capital controls. Up until the Asian crisis the Fund was poised to modify its Articles of Agreement to make the liberalization of all international private capital flows a central purpose of the Fund and to extend its jurisdiction to capital movements. But in the wake of that crisis the IMF started to change its views of capital controls—modestly and cautiously to be sure. In the post-Asian crisis context, the center of gravity at the Fund on capital controls shifted away from an unequivocal, fundamentalist opposition to any interference with the free flow of capital to tentative, conditional support for some types of controls under some circumstances.

Given the inertia at the IMF, its actions during the current crisis mark (by its standards) a minor revolution. Iceland, one of the first economies to implode in the early stages of the current crisis, has a stand-by arrangement (SBA) with the Fund that includes provisions regarding the need for stringent capital controls. The Icelandic capital controls were adopted prior to the signing of the SBA in October 2008, but the agreement with the Fund made a very strong case for their necessity as means to restore financial stability.

Change has been uneven, however, taking one step back for every two steps forward. In the raft of reports that the IMF and the World Bank have issued in the context of the current crisis, the IMF and the Bank mention capital controls only occasionally and briefly.  These reports include tepid statements about the protective role of capital controls in some countries and about their use as a temporary, last resort, while also enumerating with great care the significant risks and potential long-term costs of capital controls. Then, in the fall of 2009, we saw new signs that the IMF was continuing to wrestle with capital controls. In October Brazil imposed a modest, temporary and market-friendly control that was designed to slow the appreciation of its currency in the face of significant international capital inflows to the country. The IMF’s response was just mildly disapproving; it noted that such taxes have proven to be “porous” over time in a number of countries. But in contrast with its past behavior the IMF reaction was so muted that it could not really have been intended to deter Brazil from its strategy. The goal instead was surely to warn other developing countries against following Brazil’s lead down a policy path that the IMF viewed as a last resort. Then, in December Taiwan’s government also imposed a capital control. To date, this intervention has escaped IMF comment altogether.

The new IMF paper reaches far beyond its public statements or practice to date.  Its authors commend controls on capital inflows for having prevented economic contraction in countries that relied on them; reduced financial instability; and reduced financial fragility by lengthening the maturity structure of countries’ external liabilities and improving the composition of capital inflows. The report also indicates that ”such controls, moreover, can retain their potency even if investors devise strategies to bypass them….the cost of circumvention strategies acts as ‘sand in the wheels’” (p. 5)  The paper argues that “policymakers are again reconsidering the view that unfettered capital flows are a fundamentally benign phenomenon. …even when flows are fundamentally sound…they may contribute to collateral damage…. Not exactly your grandfather’s IMF…

Other parts of the report qualify this new openness toward capital controls, however. The report hedges in the expected ways—identifying the restrictive conditions under which capital controls can work (or be justified). But in comparison with earlier reports the qualifications are just that—they are not offered as insuperable obstacles to the use of controls. And that, in itself, represents a major advance.

This new openness on the part of the IMF is about to be tested. Asset bubbles are forming in China, South Korea, Taiwan, Singapore, and international private capital flows are flooding the most dynamic “emerging market” economies in light of the low interest rates and dismal prospects in the wealthy countries. Surely some of these countries will soon find it necessary to introduce capital controls. It will be important to watch the IMF closely as it tries to figure out just how to respond.

What we want from the IMF, of course, is a recantation of its misguided neoliberal bias of the past several decades, and it is understandable that we are not apt to be satisfied with anything less. Hence, the pessimism of so many progressives today.  But intellectual and ideological change doesn’t usually happen just that way—neatly and consistently. It can be messy, and it can entail moments of theoretical and policy incoherence. I think its best that we recognize this historical period as one of those moments—when incoherence can be productive of new thinking, new strategies and new achievements.

6 Responses to “Not Your Grandfather’s IMF: The emergence of policy space in the wake of global economic crisis?”

  1. Kevin P. Gallagher says:

    Nice article. A substantive concern is that the IMF report does not touch the question of controls on outflows. As Ilene discusses above, the immediate concern are carry trade related as asset bubbles loom in the developing world. However, when higher income nations begin to move away from their (jobless)recovery phase and start obsessing about their debt, high interest rates in the north could trigger massive capital outflows from developing countries. Guillermo Calvo, surprisingly, has recently said that “sudden stops” of inflows in the wake of this crisis could warrant controls on outflows as well. Here the mainstream economics profession is still very far from making statements like the IMF just did on controls on inflows, despite the fairly rigorous evidence showing that Malaysia (at least) was able to benefit from controls on outflows in the aftermath of the Asian crisis.

    Great minds think alike: I have a piece on the IMF inflows report in today’s Guardian:

    On the inflation targeting, that is also ground breaking. Above my pay grade but I hope some economists are now crunching the following numbers:

    1) the extent to which a 4 percent target and subsequent inflation will reduce the sovereign debt burden of particular countries; and
    2) the extent to which a 4 percent target will increase employment.

    Seems to me if, after pointing to the IMF for “legitimacy”, such estimates could be used to pressure nations (like the US) that will try to maintain the 2 percent targets. In this environment, pinpointing debt reduction employment effects carry the political moment.

  2. Nuria Molina says:

    Great article, indeed. And extremely useful and hopeful concept the one of “productive incoherence” for those of us who’ve been longing opening up some policy space on mainstream macroeconomic advice.

    Are the Europeans (led by obsessive Germany) going to tighten screws as the Fund loosens up?

    While IMF (may be) loosening up, Europeans tighten the screws…

  3. VanyK says:

    It is useful to try everything in practice anyway and I like that here it’s always possible to find something new. :)

  4. Ilene Grabel says:

    Kevin is right on both counts.

    There are cases where controls on capital outflows have protected policy space and enhanced various dimensions of financial stability in developing countries. The Malaysian experience, as he notes, is an important one to consider in this regard. And so is the case of Iceland. Despite the silence on Iceland in the new IMF report, it is notable that the Fund’s economists so clearly argued that it was necessary for Iceland to control capital outflows as the economy was unraveling.

    The Fund’s position on Iceland’s controls might create intellectual space for policymakers in other countries to invoke the “necessity defense” when it comes to controlling both inflows and outflows during times of heightened financial risk. Advocates of increased policy space can use the Fund’s defense of Iceland’s capital controls to promote debate on the possible uses of outflow controls. Iceland and Malaysia’s use of outflow controls underscores the importance of reclaiming the right to manage international capital flows, a right that has been compromised in many bi- and multi-lateral trade and investment agreements (as work by many progressive economists and civil society groups has shown).

    Like controls on inflows, controls on outflows are among the many policy tools that should be available to developing countries. Toward this end, some years ago Gerald Epstein, Jomo KS and I wrote in a G24 paper that controls on inflows and outflows should be considered (along with a range of other measures) “capital management techniques.” In that paper we describe the performance of many types of capital management techniques that have been deployed in a variety of national contexts

  5. Smitha Francis says:

    Good piece. In fact,Jonathan Ostry, the IMF’s deputy research director and principal author of the new IMF staff paper on “The role of capital controls” says the change in IMF position was “evolutionary.”
    Although this change in the position of the IMF is indeed noteworthy, what will become crucial and more relevant on the ground for many countries in the context of the various RTA and BIT negotiations, is the extent to which countries can maintain their sovereign right to put in appropriate controls on inflows and outflows, with increasingly broader ‘definitions’ of ‘investment’ being pushed for by developed countries in these negotiations.

  6. Ilene Grabel says:

    You are absolutely right. RTAs and BITs have been powerful constraints on policy space in the developing world. It is heartening that some countries have begun to rethink the terms of the agreements that they have signed since many of them: a.) restrict the right to pursue a range of developmentalist policies, b.) empower juridical bodies (such as ICSID) and corporations over elected governments, and c.) in practice, don’t even achieve their most basic objective, which is to promote investment.