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Building a Global Mess

August 3, 1999

[This piece ran in the Financial Post, August 3, 1999.]

Economists and politicians who talk about the world economy these days
are increasingly advocating a "new global financial architecture." What
many of them wish to do is give the International Monetary Fund (IMF) new
powers over the world's economies. In practice, this means giving the
United States Treasury and its new secretary, Lawrence Summers, control
over the world's economies. Why? Because for the IMF to take action, 85% of
the member votes must be in favour, and the U.S. government controls a
whopping 17% of the votes. You do the math.

But the IMF already has exerted a great deal of control over the world's
sickest economies, and the results should have humbled IMF officials. The
best kind of "global architecture" is one without the IMF and, indeed,
without any international regulatory bodies.

Ironically, the IMF's original mission, established in 1944 at Bretton
Woods, was to support fixed exchange rates, a mission that should have
ended in 1971 when exchange rates were floated. But after 1971, the IMF --
like virtually all government bureaucracies that find the world has
outpaced them -- looked around for a new mission. Unfortunately, it found
one.

The IMF now lends, at below-market rates, tens of billions of dollars to
governments that have messed up their countries' economies. In 1994-1995,
for example, a consortium including the IMF, other international government
agencies, and the United States and other governments subsidized a
$50-billion loan to Mexico (all figures in U.S. dollars).

The IMF claims
Mexico as a success story, and it may well be, by the IMF's standards.
Certainly, the foreign banks and other lenders that had lent money to the
country were bailed out. But per-capita GDP in Mexico is not yet back to
where it was before the country's 1994 economic crisis. To claim the
bailout as a success in a broader sense, IMF supporters would have to
establish that the lot of the average Mexican would be much worse had the
IMF and other international agencies not acted. They have not done that.

Even if the Mexican bailout had been a success in this broader sense, the
IMF subsidy sent, and other bailouts are sending, two bad signals. First:
If you're a government official who screws up your economy enough, the IMF
will bail you out. Just this week, for example, the IMF loaned another
$4.5-billion to the Russian government, $1.9-billion of which will be used
to pay back an earlier IMF loan. The new loan was made contingent on
Russian parliamentary approval of a package of new laws. Some of the laws,
ironically, will increase taxes on Russians, as if what a formerly
communist country needs to get its house in order is to tax its people
more. The second signal the IMF bailouts send is to investors, who will
make much riskier investments than otherwise because the downside is
covered. Investors are saying, in essence, "heads I win, tails I break
even." Neither foreign governments nor investors are missing that signal.

In a recent Fortune article, MIT economist Paul Krugman minimized the
IMF's harmful effect because it has "very little actual money." But apply
that same reasoning to the 1980s U.S. savings and loan crisis. Just as the
IMF subsidizes investors' downside risk, the Federal Savings and Loan
Insurance Corp.'s (FSLIC) deposit insurance gave depositors zero incentive
to monitor the S&Ls' loan portfolios. In 1983, shortly before the S&L
crisis was at its worst (in the end, it cost more than $175-billion in
present-value terms), the FSLIC had only about $6.4-billion in the kitty.
By Mr. Krugman's reasoning, the S&L crisis didn't happen. Think of the IMF
as a giant FSLIC. The crucial factor is not the IMF's funds at any point in
time, but how much more it can get. Just recently, the U.S. government gave
it $18-billion.

Disappointingly, even Harvard economist Martin Feldstein, my former boss
at the Council of Economic Advisers and generally a critic of government
spending and regulation, advocates a large role for the IMF. He recently
laid out a Rube Goldberg scheme for giving the IMF control over
international capital movements. He would have governments of
emerging-market countries borrow from the IMF, based on collateral. But the
collateral would be a share of the foreign exchange earned by that
country's exporters.

Mr. Feldstein writes: "A country that borrows from
this [international credit] facility would automatically trigger a
legislated diversion of all export receipts to a foreign central bank like
the Federal Reserve or the Bank of England, with exporters then paid in a
mixture of foreign exchange and domestic currency." In other words, Mr.
Feldstein would have U.S., British and other governments partially
nationalize assets of emerging economies' exporters. This hardly sounds
like a recipe for improving those countries' economies.

The best thing that can be done with the IMF is to end it. The basic
problem with the IMF cannot be fixed. It is spending (its lending often
turns into spending) other people's money, and, as the saying goes, "if
you're paying, I'll have lobster." People are always much less careful with
other people's money (if those people have no legal recourse) than they are
with their own.

Last year, when Russian official Anatoly Chubais bragged to the Russian
press that he had "conned" the IMF and its chief negotiator, Stanley
Fischer, none of us taxpayers who paid the price could legally take action
against Mr. Fischer. He wasn't fired, and he and the IMF have continued to
make loans. An even greater "moral hazard" than is implicit in IMF loans is
the moral hazard in giving such power to a small group of people. Their
power must end.

If we do away with the IMF, what should the United States, Canada and the
other industrialized countries do to help make the economic world safer?

The main thing we can do is avoid putting barriers in the way of the
crisis countries' exports. One of the few bright spots in Asia's current
situation, for example, is its ability to ship goods to the United States
and other countries. But the Clinton administration is using the dimmer.
After telling Asian government officials at the November meeting of the
Asia-Pacific Economic Forum that they should solve their problems by
exporting more, Vice-President Al Gore warned them to avoid exporting more
to the United States because increased exports from Asia would undercut
U.S. support for free trade. And President Bill Clinton, only weeks after
fretting about the world economic crisis, tried to persuade South Korea and
Japan to ship less steel to the United States.

We should care about people in other countries, not because their
economic conditions have a huge impact on ours--they don't--but because
those who are hurting, wherever they happen to live, are fellow humans. And
the caring solution to the world's economic problems is, as it always has
been, more economic freedom, not less. The countries that have had the most
economic freedom for the longest time have done the best economically.
Those with the least economic freedom have done the worst, due to decades
of economic oppression. Many of the world's economies face serious
problems, most of which are caused by government. Advocating more
government regulation as the solution is like seeing someone suffer and
then saying, "Suffer more."

* * * * *

DAVID R. HENDERSON is a research fellow with
the Hover Institution at Stanford University and an economics professor at the
Naval Postgraduate School in Monterey, Calif. A longer version of this
article appears in the July/August issue of Policy Options.

c) copyright 1999 The Financial Post


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