Economics and politics - comment and analysis

Did the IMF learn from its experience?

Many readers have asked us to comment on a very recent publication of the International Monetary Fund. The title of the relatively short paper is ‘Neoliberalism: Oversold?’ (it can be found here). In it, employees from the research department of the institution seem to come clean about some dogmas from the past. The paper made head waves all over the world in the meantime. The feedback has been enormous. The reaction of critical economists went from clear rejection to great euphoria.

In my opinion, both of these reactions are greatly exaggerated. The paper fits perfectly within the tradition of recent years in which the IMF makes, more or less consistently, ​​a positive impression. They certainly seem to learn from the errors of the past. Markus Diem Meier has this documented this very well here and I will and must not repeat him. The two main targets of the authors of the study are the free movement of capital and the politics of austerity – both are old acquaintances of us.

We have also repeatedly pointed out at Flassbeck-economics (here and here for example) that there are quite sensible voices within this big institution. In addition, as I have also mentioned several times in recent weeks (here for example), the US administration, including the US Treasury (this is the Department of Finance), has become very uncertain about some long-known dogmas. The influence of the Treasury on the IMF can hardly be overestimated.

A limited learning ability

This does not mean that all is well. It is characteristic that in papers of the IMF research department neoliberalism is always mentioned, but never neoclassical economic theory. Neoliberalism is apparently regarded as an exclusively political phenomenon, which has led to some distortions because politicians went too far or made the wrong decisions.  The failure of the theoretical framework, which underlies neoliberal policy, is never dealt with. According to the IMF, there is no such failure. Neither is there a failure of monetary theory, which remains completely dominant within the IMF. One of the main ideological foundations of austerity, such as the equivalence theorem that is attributed to David Ricardo, is never seriously criticised. Although the authors admit that the influence of capital markets on states is ‘overplayed,’ the assumed essential dependence of governments to these markets is never called into question.  The learning ability remains limited.

The infinite damage that all of this, in particular the treatment of free movement of capital, has done to the world is more than sufficient proof of how incredibly destructive these policies have been. The authors cite their new head, Maurice Obstfeld. They consider the following as being a critical statement on the free movement of capital:

“As Maurice Obstfeld (1998) has noted, ‘economic theory leaves no doubt about the potential advantages’ of capital account liberalization, which is also sometimes called financial openness. It can allow the international capital market to channel world savings to their most productive uses across the globe. Developing economies with little capital can borrow to finance investment, thereby promoting their economic growth without requiring sharp increases in their own saving’. But Obstfeld also pointed to the ‘genuine hazards’ of openness to foreign financial flows and concluded that ‘this duality of benefits and risks is inescapable in the real world’.”

What Obstfeld said in 1998, and what was meant to be interpreted as a progressive opinion, is in reality a huge step backwards. Anyone who still believes today that capital markets transfer savings efficiently and rationally around the world and that developing countries receive (and require) more capital, because otherwise they would have to ramp up their savings, which are insufficient for their endogenous development is, I am sorry to say, intellectually challenged. I cannot take anyone serious in anything that she or he is saying who still believes that ‘economic theory’ (which one?) shows that there can be no doubt about the benefits of the free movement of capital.

If it is true that capital markets are necessary as well as efficient, how can it be explained that it are precisely those developing countries which have been most successful in catching up with the industrialised countries imported absolutely no net capital from the rich countries? China is, of course, a prime example, but, surprisingly, neither Japan nor Korea depended on capital from the North for their development. And when Korea, for a short time in the 1990s, stimulated capital inflows, it immediately fell into the greatest crisis in its recent history. How is it that a country such as Brazil, which has been a favorite country of emerging market investments, has so greatly suffered from ‘capital inflows’ (see the series on developing countries in our archive – the first part can be found here)?

Absurd economic theory remains dominant

No one who believes in children’s stories about savings which are distributed around the world by efficient capital markets and always find the right host, is capable of understanding the great financial crisis of 2008/2009 or the several currency crises that the IMF had to deal with during the last twenty or so years. The IMF caused so much damage, precisely because it made the wrong diagnoses (supply problems and/or high public debt). As a consequence, it prescribed fundamentally the wrong therapies (liberalisation and austerity). A subsequent admittance that the sudden stops (i.e. reversals) of capital flows caused the initial problems simply has no meaning or bearing on reality. Ultimately, it is very simple: those who do not fundamentally question the thesis of the efficiency of capital markets and who do not admit that speculative capital flows under flexible exchange rates (which the IMF consistently recommended for the developing countries) lead to massive price and trade flow distortions and to major crisis, do not or do not want to understand anything.

The same applies to the debate on austerity. The paper makes tiny concessions without actually debating the importance of demand-side effects as part of the total demand of an economy. Here one would have very much wanted a debate on the net fiscal balances of the various economic sectors, showing, among other things, that countries such as Germany, which are willing to pay off the public debt, can only do so if they outcompete other countries because only then their ‘savings’ can be ‘absorbed’ by the surplus countries.

That the IMF now admits that inequality – a topic so much in vogue nowadays – increases by both free capital markets and austerity policies is in fact nothing but an elegant evasive manoeuvre of the part of the authors of the ‘neoliberalism oversold’ study and not the essence of the problems. That, for example, large currency crises increase inequality is very well possible, and one can justifiably deplore it. But if at the same time great unemployment arises, when desperation, absolutely poverty and political instability dramatically increase because national economic policy-makers, under the guidance of the IMF, react completely wrong to the problems by implementing austerity, then, ultimately, rising levels of current inequality are of minor importance. The real damages being done lie in the absolute loss of income and wealth. This might or will take many generations for the poorest parts of the population to once again have decent future prospects. Missing in the IMF discourse is the story of the poor, who are unable to save and have to rely on some ointment (and in some cases on an iron fist). They did not enjoy any income growth for many years and now they are fooled by the discussion on inequality. It is not that such a discussion is not necessary, it absolutely is, but on the condition that the real relationships are being understood and that the real causes of inequality are being dealt with (see my article here).

P.S.: It is more than ironic that the IMF authors use Stanley Fischer (today’s First Deputy Managing Director of the Federal Reserve) as their chief witness for the scepticism that prevails today about the importance and the risks of short-term capital flows. They quote Fischer asking “What useful purpose is served by short-term international capital flows?” This is almost literally what Oskar Lafontaine and I asked in all international meetings and to Stanley Fischer himself (who was then Deputy Managing Director of the IMF) in 1998. No one was able to provide us with an answer. We received nothing more than something close to Obstfeld’s senseless declaration quoted above. It should also not be forgotten that the same German and international media, which today feign great understanding of the IMF’s policies and the world economy in general had at that time nothing else in mind than to silence those who asked such embarrassing questions as quickly as possible.