Both the International Monetary Fund (IMF) and World Bank (a.k.a. the International Bank for Reconstruction and Development – IBRD) were created in 1944 in Bretton Woods to aid world macroeconomic stability and economic growth. Since 1944, the roles of the IMF and IBRD have evolved.
The IMF aims to deliver international macroeconomic stability and provide loans for countries experiencing an exchange rate crisis or unsustainable current account deficit. Additionally, the IMF aim to alleviate poverty in LDCs. The IMF’s loans come with conditionalities designed to stabilize an economy and ensure it lives within its means (i.e. make imports less than exports).
The IBRD was initially created to aid the reconstruction of Western Europe after the destruction of World War 2. Afterwards, the IBRD’s role eventually extended to helping LDCs develop by providing low interest loans, interest-free loans and grants to develop the infrastructure, health, education and communications. The IBRD’s loans come with market based conditionalities attached that aim to increase the long-term efficiency of the country.
An LDC usually receives a loan from the IMF and/or IBRD with the conditionalities of both attached. IMF conditionalities are designed to stabilize the economy in the short-term and IBRD conditionalities are designed to promote structural change and efficiency in the long-term. IMF loans are labelled Poverty Reduction Strategy Papers (PRSPs) and IBRD loans are labelled Structural Adjustment Policies (SAPs). Conditionalities include:
Stabilization 1) Tight Monetary Policy.
A higher interest rate to decrease and control inflation, making it easier to plan and invest.
2) Contractionary Fiscal Policy.
A decrease in government spending and increase in taxation. Allows the country to repay the loan and avoid a fiscal deficit and further loans in the future.
3) Current Account Surplus.
An exchange rate devaluation to increase international price competitiveness, exports are cheaper and rise, imports are dearer and fall and the current account moves towards a surplus.
Structural Adjustment 1) Trade Liberalization.
Trade liberalization so that the country specializes in its comparative advantage.
2) Capital Account Liberalization.
Capital market liberalization, allows capital to easily flow in/out of the economy, attracts FDI and MNCs. 3) Privatization.
Privatization, break up state monopolies to increase competition and the efficiency of industries.
Criticisms of Conditionalities Many problems exist with IMF/IBRD loans to LDCs:
A tight monetary policy and contractionary fiscal policy means AD falls, income falls and unemployment rises. LDCs suffer further because living standards fall even though they are already low, so more people fall into poverty.
2) Poorest Hit Hardest.
A contractionary fiscal policy may mean the government reduces spending on projects targeting the poorest members of society. For example food subsidies may be removed, meaning the poorest families cannot afford basic foods.
3) Uncompetitive Domestic Firms.
Domestic firms may struggle to compete with international firms, so domestic firms go bust and unemployment rises.
4) Western Imperialism.
Attaching conditionalities may just be a way for the US to spread market forces and Western imperialism rather than to help LDCs develop.
5) One-Size-Fits All.
Conditionalities are basically the same for every country regardless of their unique situations. Country A could be in a recession so austerity measures like a tight monetary policy and contractionary fiscal policy will cause AD to fall and deepen the country’s recession. Country A requires a loose monetary policy and expansionary fiscal policy to boost AD and pull the economy out of a recession. Stiglitz claims that capital account liberalization was the single most important factor leading to the 1997 East Asian financial crisis. East Asian economies needed capital controls to prevent capital flight.
6) Hot Money.
Liberalizing the capital account means foreign investors can quickly pull capital out of the economy. At the extreme, speculation could cause capital flight, where there is a large and dangerous outflow of capital from a country. This creates volatility and instability in the country, making it harder to plan and invest. Also, during a recession, funds leave the economy when they are required for investment to boost AD. When Thailand’s Baht collapsed in 1997, Thailand were basically forced to accept a loan from the IMF and liberalized their capital market. This lead to capital flight as what followed was a mass exodus of capital flows out of the country.