“We were all Keynesians now,” said Richard Nixon, back in 1969. If it was true then, it didn't stay true for long. The rise of monetarism and neo-liberalism in the 1970s sidelined the once-dominant theories of British economist John Maynard Keynes
Nowhere was the decline of Keynes' ideas, and their replacement with the ideology of neo-liberals like Ronald Reagan and Margaret Thatcher, more apparent than at the global financial institution created after the second World War to implement his style of economic management on a global stage: the International Monetary Fund.
Now the wheel has turned again. In our new financial crisis, Keynes has become fashionable. Politicians across the developed world – Gordon Brown and Barack Obama among them – are implementing massive borrow and spend programmes, as a way of replacing vanishing consumer demand and steering their economies out of recession.
This is exactly the kind of economic management that the IMF was created to enable. The Bretton Woods conference of 1944 established the IMF as a way of lending countries the money they needed to finance deficit spending, so long as it was aimed at stimulating economic recovery. Without this support, the argument went, countries would compete with each other in a slump – for example, by devaluing their currency to boost exports and deter imports. The IMF, it was believed, would ensure global financial stability.
That was the theory. But as neo-liberal politicians – and economists – rose to power, the IMF's agenda gradually changed. Instead of lending money to finance spending and stimulate economic recoveries, its loans came with draconian strings attached. These “structural adjustments” forced recipient countries to adopt neo-liberal economics: governments were told to privatise states assets, such as power and telecommunications utilities, to implement austerity budgets, and reduce domestic subsidies for basics such as food.
Thomas Gangale of Alaska and San Francisco State University described a typical outcome of IMF assistance: “Government workers are laid off, creating unemployment. Government services are reduced, adversely affecting the poorest members of society. Government assets are sold off at fire sale prices to raise money to pay off debts. Often the private investors who take advantage of these opportunities cut services and raise prices in order to operate these formerly government-owned assets at a profit. Interest rates are driven up in order to attract foreign investment; however, doing so drives domestic companies out of business, creating even more unemployment.” The IMF, wrote Mr Gangale, became “a twisted child.”
The importance of adaptability
With Keynesianism back in the ascendancy, what future does the IMF have? At an event organised by the Per Jacobsson Foundation to debate the IMF's future, Andrew Crockett, President of JP Morgan Chase International, said the fund, in the course of its 64-year history, had shown itself to be adaptable as the world economy changed. But this time, he said, according to a report of the event published by the IMF, “the transformation of the IMF's role in the international financial system will need to be more wide-ranging than in the past.”
Speaking at the same event, Stanley Fischer, a former IMF First Deputy Managing Director and now Governor of the Bank of Israel, said there were good reasons why the IMF had not been successful in addressing the build-up in global imbalances that had preceded the crisis. “The fund's role in patrolling the exchange rate system didn't work – something we already know,” he said. “But we also know why it didn't work. For the fund to have succeeded, it would have had to mediate between the country with the largest population in the world and the country with the largest GDP in the world, and get them to reach an agreement that they were incapable of reaching bilaterally. China was not willing to change its strategy of operating with an undervalued exchange rate, which has been an extremely successful one from the viewpoint of growth.”
The IMF wasn't solely to blame for its lack of influence, said Jean Pisani-Ferry, Director of the Brussels-based think tank Bruegel. The IMF's Spring 2007 Global Financial Stability Report had accurately described the first phases of the crisis, he told the event, and its Spring 2008 report had also been much more accurate than analysis provided by other international institutions and national governments. “The IMF has gained – or regained – intellectual credibility,” he claimed.
But does the world still need an IMF? Most speakers at the event said that it did, but the fund faced significant challenges in fulfilling its mandate in the world of today. As Mr Fischer put it: “How should the fund operate in the modern world in which financial markets are a much more important source of financing than they were 60 years ago, in which governments are less inclined to think in terms of what's good for the international system as a whole, and in which there are many more international economic organisations? This is really at the heart of many of the dilemmas currently facing the fund.”
Dominique Strauss-Kahn, IMF Managing Director, tried to address that question in a recent speech on the future of the IMF – a future that he said “seems fluid and uncertain.” Mr Strauss-Kahn pointed to the fund's founding Articles of Agreement, which stated the need to promote global financial stability and to help members to adjust their balance of payments “without resorting to measures destructive of national or international prosperity.” These objectives remain valid today, he said, as the fund tries to manage another chaotic period in the global economy: “The question is how to do it, in a global economy which is very different from that of the 1940s.”
The answer is twofold, argued Mr Strauss-Kahn: first, restore stability; second, “we must look ahead and design a financial architecture to make the global economy calmer and less prone to economic and financial instability.”
On the first point, the outlook is grim. The global economy is continuing to deteriorate, with 2009 set to be a very difficult year and no expectation of any recovery before the beginning of 2010 at the earliest. To prevent a global depression, there must be action in three areas, said Mr Strauss-Kahn: “We need financial market measures, in order to get credit flowing again. We need fiscal measures, to offset the abrupt fall in private demand. We need liquidity support for emerging market countries, to reduce the adverse effects of the widespread capital outflows triggered by the financial crisis.”
Governments around the world have endorsed this agenda, as has the G-20. Some have started to implement it, “But the actions taken so far are not enough. We need more,” said Mr Strauss-Kahn. The fund would help by monitoring risks at the global level and providing timely technical advice on financial market issues; deploying its expertise and experience on fiscal issues to help finance ministries find the best ways of calibrating and implementing fiscal stimulus; and by helping emerging economies design good economic programs, and by providing sufficient finance to support them, “with conditionality tailored to the goals of containing the crisis.”
One way of achieving these aims, said Mr Strauss-Kahn, is to help support aggregate demand – that's good old fashioned Keynesianism. “Fiscal stimulus is now essential to restore global growth,” he said. However, the fund is still telling some countries to reign-in their budgets. Isn't this a contradiction?
Mr Strauss-Kahn says not. Fiscal stimulus should be undertaken widely, and the more countries that engage in stimulus, the smaller will be the actions that any individual country will need. But not every country is in a position to join in. “There are some emerging market countries that have financing constraints – either high costs or inability to finance deficits at all – which mean that they need to contract their budgets rather than expand them. Others are constrained from fiscal stimulus by high levels of debt,” said Mr Strauss-Kahn. “It is cases like these that explain why in some of the programmes the fund is supporting at the moment, we are calling for some fiscal retrenchment, despite our call for global fiscal stimulus. If there was fiscal room for manoeuvre in these programme countries, we would say ‘use it'. But often there is no room for manoeuvre. In fact, in the absence of fund support, countries would have to contract even more, because financing is so tight.”
The need for this stimulus is urgent, said Mr Strauss-Kahn, as spending and investment dries up. “Every day brings additional indications that the psychology of individuals, households and firms has changed sharply in the past year,” he said. “The more profound that change, the greater the fiscal effort that will be needed to offset it and to restore confidence.” The world economy is facing “an unprecedented decline in output.” Substantial uncertainty is limiting the effectiveness of some fiscal policy measures, said Mr Strauss-Kahn, and the IMF anticipates that the negative growth effects will last for some time.
What do we need?
Bottom line: the global fiscal stimulus should be about two percent of world GDP – or $1.2trn, he said. “This may make a sizable difference to global growth prospects and substantially reduce the risks of a damaging global recession. But these two percent are an average, while some countries can't do anything, others have to do more.”
So far, Keynes would approve. Mr Strauss-Kahn also said spending should be focused on troubled sectors like housing and finance and transfers to low-income households, because they are most likely to face credit constraints and because they would be most likely to raise their spending. Good examples would be greater higher unemployment benefits, increased tax benefits for low-wage earners, and expansion of in-kind benefits covering basic needs such as food, he said. He talked about the “multiplier effect”, whereby spending in certain areas is thought to give a higher bang for the buck. He also pointed to the value of investment spending, on areas such as state-funded capital projects. “Since the slowdown is expected to be long lasting, investment spending, which typically has a longer gestation period than many other measures, becomes a more appropriate policy tool in the current circumstances,” he said. “Investment projects that are already in the works and can be implemented quickly, and those with good long-run justification and likely positive effects on expectations of future growth, like President-elect Obama's Manhattan Project for energy saving, are good ideas.” Again, all very Keynesian.
Temporary reductions in personal income and sales taxes “could also be envisaged,” he continued. “But we would not recommend reduction in corporate tax rates, dividends and capital gains taxes or special incentives for businesses. These are likely to be ineffective and difficult to reverse.” Not very neoliberal.
So perhaps the IMF has returned to its roots after all? “Good brakes are important too,” Mr Strauss-Kahn cautioned, and even advanced economies need to keep an eye on fiscal sustainability, in case their spending provokes an adverse reaction from the financial markets. But “At present, the most urgent need is for a strong foot on the accelerator of fiscal spending,” he said.
In a sense, it doesn't really matter what the IMF's exact role is. “What matters is that we make a useful contribution,” said Mr Strauss-Kahn. “We have the tools to do that. If we deploy them well, and help our members, then the IMF will have a good future. More importantly, it will be doing its job, and therefore give the world a better future. All around the planet, the people of the world have reacted to the crisis with feelings going from surprise to anger and from anger to fear. It is our responsibility to help building a world based more on humanity and cooperation than on opacity and greed.” Keynes would certainly approve of that.