After being given this analogy, the students at the IMF Institute examine the case of a typical country that lives beyond its means and ends up coming hat in hand to the Fund. For simplicity’s sake, I’ll call this country Shangri-la, and its currency the rupee; in fact, these names are used in one of the Institute’s textbooks.
Like most countries that seek the Fund’s help, Shangri-la is running a large current account deficit—a term that is roughly equivalent to a trade deficit, though it’s a little broader. Shangri-la’s imports substantially exceed its exports, and the money the people of Shangri-la earn by providing services to foreigners—tourism, for example—still doesn’t fill the gap.
Another way of looking at the situation is that Shangri-la is spending more than it is earning—measured in hard currency. These currencies, which include the U.S. dollar, the Japanese yen, the euro, the British pound, and a handful of others, are the only currencies commonly accepted in international transactions. Without a supply of hard currency, a country can barely function in the global economy. Unfair as it may seem, the people and companies who sell oil, wheat, computer chips, pharmaceuticals, and other products across national borders will almost always insist on being paid in dollars or yen or pounds or euros (the dollar being by far the most prevalent). The Ukrainian hryvnia, Vietnamese dong, and Haitian gourde may be essential for conducting business when both buyer and seller are located within Ukraine, Vietnam, and Haiti respectively, but such currencies are usually refused as payment for goods and services outside their borders. This is not Just because richer countries tend to be more stable than poorer ones; it is also because hard currencies are easy and cheap to trade, invest, and hedge against changes in their value. The world needs a stable medium of exchange for commerce among nations, and hard currency is it.
So in a country like Shangri-la that is spending more than it is earning, exporters are earning dollars, yen, and other hard currencies by selling their products to foreigners, and the tourist trade is bringing in some more. But Shangri-la’s importers are spending all this and more on the goods they buy from abroad, and their demand for hard currency is draining the central bank’s reserves.
Just like the individual in Khan’s analogy, Shangri-la can borrow on credit when it is spending more hard currency than it is earning. For example, its companies may obtain loans of dollars or yen from international banks to buy foreign machinery. Sometimes running a tab makes good economic sense—especially if, say, the foreign machinery purchased on credit can be put to good use producing high-quality products for export. In the nineteenth century, the United States, Canada, and Australia pursued a similar economic tack, running large trade deficits and borrowing heavily from abroad to finance the development of railroads and other infrastructure.
But if Shangri-la runs too large of a tab, it may suddenly find itself in the same situation as the individual who has maxed out on his credit cards. Maybe there’s an unexpected shock—a sudden surge in the price of imported oil, for example, or a dip in the price of a key export, such as coffee or computer chips. Whatever the reason, Shangri-la has developed what economists call a “balance-ofpayments problem.” Sources of hard currency from abroad dry up, because foreign lenders conclude that for the foreseeable future, Shangri-la has little prospect of generating enough proceeds from its exports to pay all its obligations to foreigners.
At this point, Shangri-la’s finance minister and central bank governor are likely to be found stepping out of a limousine in that curved driveway in front of IMF headquarters. The Fund is the only place an overextended country like Shangri-la can obtain the hard currency it needs to obtain vital imports and keep its economy functioning. In fact, this is the Fund’s main purpose—to serve as a sort of giant credit union, in which the members (the 183 nations belonging to the Fund) deposit hard currency into a kitty and borrow from it when they are strapped. Moreover, as Khan put it, “the Fund in a sense becomes the financial planner for this country, because it has to design a program that involves reductions in spending, and policies to increase income and production, so that the country is living within the constraints of what’s available.”
Now comes the creative part of the institute’s course—where the students learn, in theory at least, how to design a rescue plan for a country that has landed in hot water. In graduate school, most have already studied the basic principles of economic policy. They have learned how to determine the proper levels for a government budget deficit and interest rates to help keep inflation and unemployment as low as possible. They have learned, too, that devaluing a country’s currency has pros and cons. If, for example, Shangri-la devalues the rupee, its exports will presumably sell better, because they’ll become cheaper relative to other countries’ goods on world markets. At the same time, devaluing the rupee increases the cost of imports to Shangri-la’s consumers, thereby lowering the country’s living standards.
“What is completely new to the students is how you put all this together in designing and constructing an IMF program,” Khan said. So, like medical students performing surgery on a cadaver, the IMF class considers a real case involving a real country that ran into a balance-of-payments problem in the not-too-distant past. The students are divided into teams of about ten each and told to produce a solution. The students’ textbooks provide them with reams of data on the country’s government budget, money supply, business investment, foreign indebtedness, and the like. They have learned, Khan said, to start with a fundamental question: “Suppose the country continues on its merry way, spending and producing as it has in the past. How much money [i.e., hard currency] would it need? So we proJect exports, imports, and so on, and then see what the gap is. If the country continues on its merry way, this is what it will need.”
The students are provided with a figure showing how large a package of loans the country can expect to obtain, given its size and importance, from the IMF and other official sources, such as the World Bank. The loans help fill the gap between hard-currency “income” and hard-currency “outgo,” but the country still needs to squeeze down its imports and increase its exports so that it can get itself on a sustainable path and earn enough hard currency to pay back the loans.
Thus the students must decide on a line of attack: Should the government slash its budget deficit by raising taxes and curbing government outlays? Should it raise interest rates and curtail the growth of the money supply? Almost certainly, their answer to both questions will be yes—the only real question is how much—because painful as those measures might be in terms of increasing unemployment, this is a country that needs to reduce its import bill, which entails a decline in overall spending. Should the currency be devalued? Again, the answer is likely to be yes. A lower value for the currency would also cause consumers to cut back on imports as foreign goods become more expensive, and by making exports more competitive, it would enable the country to sell more of its output overseas—the result being increased supplies of hard currency.
All this may sound as if the IMF trains its economists to prescribe little but torture for the countries it lends to. Indeed, as one of the institute’s textbooks euphemistically puts it: “These policies often focus primarily on containing aggregate demand.” That’s because in many cases, imposing austerity makes sense; countries living beyond their means must face the consequences eventually, and are better off doing so with an international loan to ease the adJustment.
But there’s a major omission from this line of reasoning—and once it comes into play, Khan said, “it’s not clear our economic theory works.” Here’s the problem: In today’s world, crises can erupt for reasons quite different from those at play in the traditional case of a country running a large current account deficit. With capital more globally mobile than ever, countries are proving susceptible to sudden withdrawals of foreign money for all sorts of reasons, often stemming from weaknesses that emerge in their banking systems, where considerable foreign funds may be invested. They can
thus run out of hard currency even though they haven’t been living beyond their means in the conventional sense.
To put it in the Jargon of economics, such countries are suffering “capital account crises” rather than “current account crises.” Before the 1990s, the IMF was largely confined to dealing with current account crises. Many nations, especially in the developing world, sharply limited the amount of money foreigners could invest in their stock markets or lend to their companies. To the extent they borrowed from abroad, the purpose was essentially to obtain the hard currency necessary to pay for imports or to finance government infrastructure proJects. When they lived beyond their means and maxed out on their credit cards, the reason was almost invariably that the government had been overspending—running large budget deficits—and pumping up the economy, thereby importing foreign goods in abundance. The IMF’s loans enabled them to avoid going cold turkey on imports, and its tried-and-true prescriptions of austerity helped them bring their national lifestyles within their productive capacities.
But the new types of crises—some IMF officials call them “twenty-first century crises”—may arise for entirely different reasons. Now that the Electronic Herd is much freer than before to send money zipping across borders, a country may suffer a precipitous loss of hard currency simply because many Herd members that have invested in that country come down with a severe case of the heebie-Jeebies. The country’s government may be running a tight ship with its budget, and its central bank may be keeping the money supply within prudent bounds. But those factors may count for little if the Herd starts to worry that, say, the country’s banks have been making bad loans and may lack the hard currency to pay their foreign obligations.
In such cases, the IMF’s traditional remedy of deep budget cuts and the like isn’t necessarily logical; it may even make matters worse—and in Asia, Khan acknowledged, the Fund was slow to shed its old mind-set: “To be very candid, in the countries we deal with, we find ourselves making standard policy prescriptions. What are the knee-Jerk reactions? Well, very seldom would you go wrong if you said ‘raise interest rates and tighten fiscal policy.’... I thought the teams in Asia were sort of conditioned by the framework they had in mind. As you can imagine, our more recent courses have stressed ‘let’s think these things through. Do we need to tighten fiscal policy? And why?’”
Worse, he added, most IMF staffers—with their heavy orientation in macroeconomics—lacked a good grasp of the complex banking issues that rose to the fore in Asia. In an acknowledgment of this shortcoming, the IMF Institute, which offers training to seasoned Fund economists as well as new recruits, hastily expanded its curriculum after the crisis erupted. “A lot [of the newer course material] is related to financial sector issues, where the IMF staff did not have necessary expertise at all,” Khan said, adding that in 1996 the institute had “no course in that area” for the staff but planned to offer ten one-week courses on banking-related topics in 2000.
“A very large majority of countries that come to the IMF are still suffering to a large extent from current account crises,” Khan emphasized. “So we still focus largely on the current account [at the institute]. Capital account crises only happen to countries that can attract large amounts of private capital”—and among developing countries, that is still a minority.
But it’s those newfangled crises that are the most damaging, the most dangerous to other countries, and the most difficult to halt. “We don’t know what underlying economic relationships will hold in panic situations, and capital account crises are panic situations,” Khan said. “People are trying to run as fast as they can. When a true panic hits, all bets are off. Some things may work, others may not. You Just don’t know how to respond.”
While being taught the standard approach for saving a typical economy in distress, young IMF staffers soon learn that they are expected to function inside an extremely tight-knit, hierarchical organization.
A team of economists going on mission to a troubled country brings along a document, typically the product of weeks of debate within Fund departments, spelling out a negotiating position on a list of policies for the country to adopt. When negotiations commence with the country’s officials, team members are expected to stick to this preagreed approach, with only modest leeway granted to a few trusted mission chiefs. Even when they find themselves sympathizing with the obJections raised by the country’s officials—as they often do—the whole issue has to be debated again, privately, with IMF headquarters before Fund negotiators make maJor concessions. Revealing internal differences of opinion to outsiders constitutes a serious breach of discipline, because of the Fund’s need to convey (both to the country’s authorities and to the markets) the impression that it knows what it is doing.
There are, to be sure, many internal disagreements. The departments with a regional focus, such as the Asia and Pacific Department, often tangle with departments that have global responsibilities, including the Research Department and, most particularly, the Policy Development and Review (PDR) Department. Known within the IMF as “the thought police,” PDR is responsible for ensuring that a program in a particular country conforms to the institution’s standards and is broadly consistent with programs in other countries, one reason being to minimize complaints about favoritism. Thus there is a natural tension between departments with specialized knowledge about conditions in individual countries and departments such as PDR that are immune to “clientitis.” When economists in one department can’t agree with their counterparts in another, the department heads sometimes seek compromise; if they can’t agree, the managing director or deputy managing director must resolve the dispute.
“I can tell you for sure there are heated arguments, but they are resolved internally,” said Michael Dooley, a former IMF staffer now teaching economics at the University of California at Santa Cruz. “Will it appear from the outside as if the Fund is a pretty uniform place? Yes. If it were otherwise, there would be howls of complaint—like, ‘How come you guys can’t make up your minds?’ You don’t want an institution like the Fund changing its mind every week about how to do things. Financial markets are watching. While you negotiate, Rome is burning.”
Still, debate takes place within a highly structured pecking order in which lower-level economists, having expressed an opinion, close ranks behind a superior’s decision even if they disagree with it. “There is a very clear hierarchy,” said Laura Papi, who left the Fund in late 1997 to Join a banking firm. “As a team member you discuss things, but the head of the mission has the final say on what the mission’s view is on Country X. Now, he is not the boss of the IMF either; he will discuss his views with the Front Office—a group of very senior people heading each department—and then Front Office people have contacts with management [the managing director and first deputy managing director].” Even when disagreements surface within a mission team, “they will disappear,” Papi continued, “because the mission chief will say, ‘I think X, even if you think Y.’ Then he goes to the Front Office and says, ‘We believe X.’” A mission team member, she added, “wouldn’t dream of sending a memo to management saying, ‘By the way, I think the stance my mission chief is taking on Country X is completely wrong.’ That would be unheard of.”
Economists from the World Bank, who sometimes work in Joint missions with the IMF, express awe at the almost military manner in which Fund staffers defer to their superiors. This protocol is in stark contrast to the code of conduct at the World Bank, an institution devoted to long-term development loans, whose economists or irrigation specialists or environmental experts might embark on a lively disagreement right in front of, say, a borrowing country’s deputy finance minister. When an IMF mission enters a room to conduct a negotiation, it is often easy to tell who ranks where; one World Banker likens it to “a mother duck leading her baby ducks.” The mission chief typically sits in the middle of the table and does most of the talking, allowing immediate subordinates to chime in on issues requir
ing their specialized expertise; lower-level staffers are likely to remain silent. Another World Banker recalled a stint in the Fund and how, on his first day there, one of his new colleagues explained the difference between the two institutions: “The Bank is the Stanford marching band,” the IMF man told him, referring to the comically chaotic formations performed at Stanford University’s football stadium. “The Fund is the Army.”
Behind the hierarchy is a fairly rigid system of promotions that reserves high-ranking posts for people with considerable seniority. Unlike in many private-sector firms where talented people are promoted to management at relatively early ages, the economics Ph.D.s Joining the IMF at the age of twenty-five to thirty can expect to wait at least until their late thirties to assume management responsibility—and then only if they are high flyers. The result is a staff headed mainly by people who have worked at the IMF for two decades or even longer, a feature critics often blame for making the Fund hidebound and sluggish at responding to the changing nature of the global economy. There are, to be sure, examples of senior officials Joining the Fund from outside—Timothy Geithner, a former U.S. Treasury official who was named director of the Policy Development and Review Department in 2001, was one. But they are exceptions, not the rule.
At the very top, however, are two people who have been placed in their Jobs by the world’s most powerful governments—the managing director, who is traditionally a European choice, and the first deputy managing director, who is traditionally an American choice. The individuals who hold these positions often stamp their personalities on the institution they head.
The Chastening Page 4