IMF AUSTERITY IS ALIVE AND WELL
The ANC has historically been strongly opposed to SA approaching the IMF for funding. New research is likely to deepen that antipathy
The International Monetary Fund (IMF) has a major embarrassment on its hands. Two new research papers have slammed its policy track record, showing that IMF-mandated austerity is associated with rising inequality and poverty.
Bad timing, especially when you’re trying to shepherd a global recovery and avert a potential emerging-markets debt crisis. I
The papers were sent to journalists by the Boston University Global Development Policy Centre (the GDP Centre) on the eve of the annual IMF spring meetings in Washington. They build on a body of scholarship critical of the strict fiscal conditionality historically attached to IMF loans, especially to poor and developing countries.
The papers conclude that the IMF — which champions the sustainable development goals of reducing poverty and inequality — “has neglected the multiple ways its own policy advice contributes to social inequity in the developing world”.
Even so, the researchers credit the IMF with having undergone “significant internal reform” over the past decade. There has been a concerted trend towards attaching fewer conditions to loans and it has become more open to the use of fiscal stimulus in response to economic stress.
They also find “encouraging signs” that the fund may be treating the Covid crisis with special care, noting that recent IMF arrangements have begun to insist that health-care spending be maintained or even increased.
According to the IMF, it has increasingly emphasised the importance of social spending in the design of its programmes, particularly since the global financial crisis, when it revamped its facilities to include floors on social and priority spending.
However, the researchers believe the lender still has a long way to go, claiming that IMF-mandated social spending floors have been implemented only about half the time.
They are also alarmed by the apparent backtracking by IMF MD Kristalina Georgieva on her comments, made in April 2020, that developing countries should “spend as much as you can [on combating the pandemic] but keep the receipts”.
Late last year, she clarified that these receipts “cannot be stacked in a drawer and forgotten. They should be tracked, publicised and audited.”
According to the researchers, “these comments point to growing fears of a coming austerity shock. The IMF has already advised countries to restart fiscal consolidation in 2021, and through its loan-for-reform programmes it can ensure that this takes place.”
They warn that “a rapid, radical, and premature return to austerity could further worsen poverty and inequality”.
In fact, the IMF seems to agree that a premature return to austerity would be a mistake. The challenge, it says, is to balance the risks from large and growing public debt — which reached an unprecedented 97% of GDP on average globally in 2020 — with the risks from premature withdrawal of fiscal support, which could slow the recovery.
As such it has encouraged member countries to first increase stimulus and efforts to improve the production and distribution of Covid-19 vaccines and only once the public health crisis is over, to begin to repair their public finances. This process, it says, should be done gradually, in sync with the easing of lockdown restrictions so economies do not suffer a sudden loss of support.
In the first paper, “IMF Austerity Since the Global Financial Crisis: New Data, Same Trend, and Similar Determinants”, the GDP Centre researchers set out to probe whether IMF programmes have indeed become less stringent since the 2008/2009 global financial crisis, in line with softening IMF rhetoric.
Using a new data set that measures the depth of the fiscal adjustment required in 154 IMF arrangements from 2001 to 2018, they find that, contrary to perceptions, IMFrequired austerity remained commonplace and did not diminish in intensity after the financial crisis.
Austerity also wasn’t applied even-handedly among borrowers facing similar economic pressures; countries’ foreign economic and diplomatic relationships mattered.
Specifically, the paper finds that borrowers tend to receive less stringent conditionality the more voting power they enjoy at the IMF and if they’re strongly tied to Western Europe,
What it means: New data shows that IMF-backed austerity hurts everyone except the top 10%, deepening poverty and inequality
either through trade or diplomatic channels.
Austerity is also tempered when borrowers receive significant aid from nonmembers of the Organisation for Economic Co-operation & Development (in effect, from China), ostensibly as this raises their bargaining power and buffers their need to accept IMF conditionality.
However, borrowing countries are more likely to face austerity if they are host to significant foreign direct investment, particularly from Western Europe.
The researchers posit that smaller developing countries may experience diminished bargaining power in relation to the home countries of major investors, especially if these are in Western Europe or the US and hold significant power in the IMF.
“The intuition here is that connectivity builds relationships that can alter the bargaining power of parties negotiating IMF arrangements,” say the researchers.
Given that the findings seem to suggest the IMF is biased against developing countries such as SA, it wouldn’t be a stretch to see local critics using these papers to argue that the institution is inherently racist, and to urge SA to steer clear of seeking further IMF support.
In July last year, the National Treasury obtained a R70m unconditional IMF loan at an interest rate of just 1% to help mitigate the costs of the pandemic, at a time when the cost of government borrowing on the open market was almost 10%.
The IMF’s resident representative in SA, Max Alier, rejects any insinuation that the IMF is biased. “Even-handedness is a core principle in our operations and there are institutional checks and balances to enforce it,” he says.
Moreover, the fund continues to step up in an “unprecedented way” to support emerging, developing and lowincome countries. For instance, its lending to Sub-Saharan Africa last year was 13 times greater than the annual average over the previous decade; it supported 160 countries through technical assistance and training, and provided debt support to 29 of its poorest members through debt service relief.
Last week, the G20 endorsed the IMF’s proposed new $650bn allocation of special drawing rights — a highly liquid asset members’ central banks can exchange for hard currency such as dollars, yen and euros.
“This will help address the long-term global need for reserve assets and provide a substantial liquidity boost to all our members, especially the most vulnerable countries,” explains Alier.
Alier also takes issue with the researchers’ claim that the
IMF has been lacklustre in protecting social spending in the design of its programmes. He says more than 60% of IMFsupported programmes since 2012 have included quantitative targets on social and other priority spending — more than double the share during the previous decade.
“The 2018 IMF review of conditionality finds that social spending has been generally protected in IMF programmes,” he says. “Furthermore, it finds that more than a third of programmes, mostly in low-income countries, actually targeted a fiscal expansion, not a contraction.”
Turning to the extent of austerity required in IMF programmes, the GDP Centre researchers find wide variability in the fiscal adjustments required of borrowing countries. Between 2001 and 2018, the degree of adjustment typically ranged from +3% of GDP a year to almost -3%, excluding outliers (see graph).
Some of this was due to the diversity of economic situations borrowing countries faced, including differences in income levels and economic growth and inflation rates. After accounting for these differences, the paper finds most borrowers were required to tighten fiscal policy by about 1% of GDP a year.
The fiscal tightening proposed by the National Treasury to get debt to stabilise at 88% of GDP by 2025 is three times higher than this norm.
University of Free State economics professor Philippe Burger estimates that between 2010 and 2019 SA ran an average primary deficit of -1.63% of GDP. To get debt to stabilise at 88% of GDP by 2025, assuming the Treasury’s growth forecasts and
interest-rate assumptions hold, SA will need to run a primary surplus of +1.65% by 2025/2026.
Ignoring SA’s exceptional Covid-related primary deficits, this translates into an adjustment of almost 3.3% of GDP, which would put it in the league of large IMF adjustment programmes.
This raises the question as to whether SA is trying to tighten too much too fast, especially in light of the papers’ findings that harsh austerity will likely worsen poverty and inequality.
The IMF’s view, according to Alier, is that the adjustment proposed by the Treasury is “the minimum needed” to restore SA’s fiscal position to sustainability over the medium term.
However, he stresses that the IMF’s advice to SA “is that fiscal consolidation needs to be coupled with structural reforms to foster faster economic growth than [what has been] experienced in the last decade”.
The second paper, “Poverty, Inequality, and the IMF: How Austerity Hurts the Poor and Widens Inequality”, covers 79 countries in IMF programmes from 2002-2018.
It finds IMF-mandated austerity is significantly associated with rising inequality in recipient countries for up to two years, because it has the effect of increasing the income share to the top 10% of earners at the expense of the bottom 80%.
Stricter austerity is also associated with higher poverty head counts and poverty gaps.
This is because stark reductions in government spending can cause contractions in economic activity, with knock-on effects on employment and income. It may also involve cutting the number and wages of public servants, while curbing social services or support can hurt citizens most in need.
The papers will likely find a receptive ear in SA among those who believe the state’s fiscal consolidation plan seeks to cut spending too much, too fast, to the detriment of the poor.
According to the papers, such fears are well founded. Austerity hurts everyone except the top 10% of earners. But it hurts the middle class the most, plausibly because it is public servants whose wages, jobs and pensions often bear the
brunt of fiscal tightening.
In SA’s case, slightly more than half of the R265bn in planned medium-term expenditure reduction will be borne by this group through a three-year wage freeze.
However, given the extent to which public servants’ wages have been buoyed over the past decade through above-inflation wage increases, many would regard this as a necessary, even overdue, correction.
But is it really such a surprise that austerity worsens inequality and poverty in the short term in countries guilty of years of unsustainable overspending? Surely, the real issue is whether, after an initially painful correction, fiscal sustainability is restored, laying the foundation for faster growth over the longer term?
For Burger, it comes down to the twin concepts of fiscal sustainability and sustainable development. “If we can only finance expenditure by incurring an ever-increasing debt ratio, fiscal policy is unsustainable and, if not brought under control, is likely to undermine economic growth in the longer run,” he explains. “That will put further pressure on the government to cut back expenditure.”
However, if a country pursues only fiscal sustainability without paying attention to development, it runs the risk of creating political and later economic instability, which will in turn undermine fiscal sustainability.
“Thus, when it comes to fiscal sustainability and sustainable development, we need both,” he says. “One cannot be pursued without the other. And for both we need economic growth.”
For Alier, the real issue for countries that find themselves in an unsustainable macroeconomic situation, either because of wrong policy decisions or external shocks, is not whether an adjustment will take place, but how it does so.
“IMF programmes aim at facilitating an orderly adjustment by providing financing with own resources and by catalysing financing from
other partners [countries or institutions],” he explains. “This way, countries gain time to put in place policies and reforms that spread the adjustment over time and mitigate the impact on the population.
“In contrast, in the absence of financing, the adjustment would need to take [place] over a shorter period and rely on rapid-yielding policies that tend to be harsher, especially on the most vulnerable.”
So, even if Alier were to accept that economic adjustment leads to increased poverty and greater inequality in the short term, the real question, he believes, is whether such impact is greater in the context of an adjustment supported by an IMF programme or one without such support. “Running counterfactuals is obviously difficult but it would be interesting to see which countries have fared better, those that had IMF support or those that decided to go on their own,” he says.
This is beyond the scope of the GDP Centre papers but according to economics professor Douglas Irwin of the Peterson Institute for International Economics, a growing body of recent research suggests that the Washington Consensus (as exemplified by the IMF) has produced tangible benefits.
In a December blog post, he cites several examples in which researchers explicitly considered alternative scenarios, including a recent article in the Journal of Comparative Economics, “The Washington Consensus Works: Causal Effects of Reform (1970-2015)”. It finds countries that undertook sustained economic reform boosted their real per capita GDP by 16% after 10 years, compared with countries that made few or no changes in policy.
As Alier points out, at the end of the day a successful adjustment (either with or without an IMF programme) is one that lays the foundation for faster growth and greater prosperity over the medium to long term.
Austerity hurts everyone except the top 10% of earners. But it hurts the middle class the most