On the Road to Damascus? Ambiguity and Continuity at the IMF

Cornel Ban

The most recent high profile form of target practice for the expansionary austerity thesis uses a great deal of IMF research as ammunition. A senior IMF level official who managed the Fund’s involvement during the Irish crisis blasted Europe’s policy of austerity and issued dire warnings about a gloomy future if the current course of action is maintained.Has the crisis really changed the International Monetary Fund’s policy advice? The main finding of an international workshop that took place recently at Boston University was that while some remarkable changes did in fact occur in IMF policy advice, they were too modest to suggest that an economic paradigm change is imminent.

The contributors noted that this international organization took a half-step on capital account regulation, became more open to the preferences of developing countries, relaxed its erstwhile strict commitment to austerity and has become a lot more reserved towards cross-border banking and the involvement of private sector consultants in its financial surveillance teams. At the same time, they found that the Fund has narrowed the scope of its programs to a predominantly orthodox economic policy agenda, continued to make counter-cyclical policies conditional on bond market sentiment and contributed to the weakening of recovery via its continued discrimination in favor of foreign creditors.

In terms of fiscal policy, the Fund’s Article IV consultations carried out in 2012 with rich European countries advise expansions for the fiscally virtuous countries facing potential recessions (Sweden, Germany) and austerity (frontloaded fiscal consolidation) where deficits and bond market vulnerability is high (Ireland, Spain). More surprising is the fact that the IMF sees major cases of brutal austerity as either misguided or self-defeating. A slower and more gradual fiscal consolidation (albeit no backloading per se) is suggested where the government  (a) has still high deficits but faces no sovereign bond market problems (the case of Britain) and where the deficit is high but the contraction is so big that it risks undermining credibility with bond markets (the case of Spain). Furthermore, contra the “hard” austerity-via-cuts thesis, the Fund now advises that where austerity is done it should rely less on expenditure cuts and more on increasing revenue measures (Ireland, Spain), on higher property taxes on the wealthy (Britain, Ireland), and on strengthening the safety net for the most vulnerable (Ireland, Spain).

How about the effects on the Fund’s policy advice of the much-quoted WEO from October 2012 report in which the Fund seemed to turn against its erstwhile fiscal policy skepticism? Three findings stood out in this report: the size of the fiscal multipliers used for growth projections had been woefully underestimated, countries that engaged in more austerity had less growth than countries that did not and, most importantly, austerity failed to reduce public debt within a reasonable time span. This meant that some critical pillars of the IMF policy advice had been contraindicated.

Did this epistemic shift have policy consequences? The analysis of the Fund’s article IV reports completed after the October 2012 WEO suggests that three patterns of fiscal crisis economics have emerged: putting austerity on hold for the fiscally virtuous, further expenditure cuts and tax increases in the countries with fiscal imbalances, higher and more progressive taxes in countries that used fiscal consolidation to orchestrate libertarian attacks against the state.

The dominant pattern has been the reassertion of fiscal orthodoxy. In Bulgaria, Romania, Hungary, Portugal, Lithuania and Estonia the Fund praised the frontloading of consolidation and urged its continuation irrespective of the cycle. Advice for further privatizations in these dependent economies centered around the use of the resulting revenues for cutting debt and/or building buffers for future shocks. Throughout these reports, the Fund stresses the poor tax collection capacity of these countries, yet it stops short of applauding all revenue-maximizing measures. Thus, revenue-boosting measures not certified by the IMF that forced largely multinationals to share the burden of adjustment (the Hungarian sectoral taxes on banks, privatized energy companies and retailers) are criticized by the Fund as distortionary. Similarly, the Fund remains cold on the adoption of higher taxes at the top in high-income states. For example, the Portugal report stresses that Portugal’s level of taxation is high enough and that consequently further cuts in social transfers and public sector wages should remain the workhorses of austerity.

The October 2012 WEO did produce some limited effects. In two cases the Fund was more at ease with suggesting/endorsing the backloading of fiscal consolidation as a countercyclical policy. Puzzlingly, this was the case not only in the IMF advice to a country that has traditionally enjoyed safe haven credibility and a reputation for fiscal rigor (the Netherlands). The IMF also applauded short-term expansionary policies in a middle-income country (Estonia) and in low-income economy whose state nearly collapsed a decade ago (Albania). What the first two have in common are sustainable debt levels and an impeccable record with budgetary discipline during the crisis. Moreover, in the eyes of the IMF Estonia validated its theory that recoveries can be obtained through internal devaluation. Once budgetary discipline was achieved, the Fund endorsed projected increases in public capital spending, social spending, unemployment benefits, means-tested child allowances, the wage bill (following a 3-year wage bill freeze) and an increase in public investment associated with EU structural funds. This was only a qualified endorsement of mild expansionary policies, however. Such measures were accepted only so long as they were offset by reductions in current spending and were, as a result, budget neutral. Moreover, to forestall future deviations from orthodoxy, the Fund’s blessing of expansionary measures came together with praising the adoption of multi-year expenditure ceilings (already applied in Holland) and with the suggestion that they be established where they were not in the books yet (Estonia).

The final pattern is the correction of fiscal consolidation measures that seem a bit too anti-state and anti-poor even by IMF standards. This is clearly the case in Lithuania, where the IMF critiques a revenue-to-GDP ratio that is the lowest in the EU, capital taxation levels are well below the EU average and where excessive reliance on (regressive) indirect taxes is matched by very low taxation of wealth. Consequently, the Fund advises a bigger and more progressive government in terms of taxation for this exemplar of libertarian political economy. The report on Lithuania also provides an insight on what the IMF has to say about high unemployment when the country under review has already deregulated the labor market. In such cases, the IMF’s last bullets are education reforms aimed at reducing skill mismatches and boosting capital formation by reducing administrative burdens and streamlining territorial planning procedures.

In short, the crisis and the recent increase in revisionist thinking among some IMF staff seems to have opened a number of windows in the Fund but it did not lead to a Damascene paradigm shift. Instead, even as evidence that austerity is self-defeating continues to pile up, this institution seems stuck in a tense hesitation towards embracing a more expansionary and resolutely less inequality-reinforcing fiscal policy stance.

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