The IMF as catalyst
The following is an edited version of the Sir Archibald Need Memorial Lecture 2015, entitled Can The Prescriptions Of The IMF Solve The Economic Problems Of The Caribbean?, and delivered by former Prime Minister Owen S. Arthur yesterday at Grand Anse, St George, in Grenada.
Many centuries ago, the Roman poet Ovid left us the observation that “there is no excellence without difficulty”.
He could easily have been anticipating the circumstances which would forever prevail in the endeavour to create a civilization in the Caribbean.
For if even presented with the best circumstances and good fortune, the effort to constitute Caribbean nations as cohesive societies, served by viable economies that can consistently afford their citizens a very high standard
of living, would, if continually achieved, amount to a major miracle.
The contemporary Caribbean however does not face the best of circumstances, nor does it enjoy good fortune.
The long-standing and oft cited difficulties that are associated with and derive from the region’s dubious distinction as the world’s smallest and most vulnerable set of nations, have persisted and have become more pronounced.
In addition to its long-standing challenges, our region, now has to grapple with stresses which are of a more recent vintage, which are gathering in scope and intensity and which are now so massive as not to lend themselves to easy resolution.
To begin with, the typical Caribbean nation now faces the real danger of having to rely for their material progress on economic systems that are not viable.
Conditioned for centuries to depending upon preferential access to foreign markets for their exports, on high levels of domestic protection for their industries and on generous access to concessional financing to support their development, almost every Caribbean nation has, now to face the prospect of building economic systems without the benefit of such props.
All the evidence suggests that the transition from the age of preferences to the age of competitive self-reliance has had devastating consequences, as is evidenced in the case of every banana-producing economy . . . .
To make matters worse, as regards the infrastructure needed to generate growth and development, some Caribbean nations have not yet managed to put the circumstances of the 19th and 20th centuries behind them, even as they contend with those of the 21st century.
Indeed, it merits a moment’s reflection that some Caribbean countries have not yet entered the jet age. Some also do not yet have the basic physical infrastructure, such as good road networks and ports, to support high levels of economic activity.
It therefore should come as no surprise that most Caribbean nations now share the common features of low or no growth, unsound fiscal positions, high levels of debt, the loss of market share for the sectors which should be driving their development, and profound difficulties in bringing on stream new industries for these new times.
Indeed it is as if the regional economies are caught between two worlds; one that is dead or dying, the other that is struggling to be born . . . .
In addition to the fundamental problems of having to rely on economic systems that are not viable, most Caribbean states now face potentially overwhelming problems in meeting their current expenses to provide essential social services for their citizens.
However, because their debt service accounts for such a large part of revenue, many now do not have the wherewithal to fund the creative things that can spur on the development of their economies.
Some, like the member states of the OECS, which answer to a common Central Bank and as such cannot and will not print money to finance the deficits of the government, have virtually exhausted their sources of commercial borrowing. As a consequence, some have had to resort to financial expedients that can undermine the integrity and soundness of their financial sectors and their social security systems.
Others that have central banks and which can pursue independent monetary policies, have foisted problems on themselves by having their central banks print money to finance the fiscal deficits, an expedient that has triggered a loss of foreign reserves, or generated rates of inflation that are higher than their competitors’.
As we reflect on the issue as the whether IMF type policies are the ideal to help the region confront its challenges, it is pertinent to point out that the insolvency of most Caribbean states is not due to economic factors or financial malpractices only.
It is in some respects a consequence of having to meet the obligations of insular independence.
Independence has meant that Caribbean nations have had to face, on their own, obligations in respect of nation building that are expensive . . . .
It is therefore arguable that most nations have now evolved social sectors that are too large to be carried by economies which are going through transition, and that the entitlements now afforded to citizens must be paid for in new and sometimes traumatic ways.
For good measure, it should be added that the role of the state in the Caribbean is constantly being expanded, not because the state wishes to be large, but because the modern state in the Caribbean has now to spend to fend off new and formidable existential threats which require its intervention . . . .
It would be inappropriate were I not to add, for good measure, that the competitive nature of our parliamentary democratic processes is conducive to the embedding of patronage and financial tribalism as contributors to the insolvency of the state.
I have gone to this length to try to capture a snapshot of the problems that have to be addressed in the Caribbean to provide context to the merit of seeking IMF solutions to underscore the fact that these will be no easy solution –– IMF or no IMF.
Addressing the myriad problems which beset the Caribbean society will require a response, engaged in as one undertaking, that perhaps has never before confronted any other group of nations.
For Caribbean states today have to simultaneously address the lack of viability of their economic systems; the growing insolvency of the state; the disharmony between the expansion of the social sector and the decline of the economy; the surge of obligations and expectations that have come with Independence; and the preponderance of new existential threats that have to be confronted. This ought to be the context within which the prescriptions of the IMF must be evaluated.
And such a discourse is made all the more necessary because the IMF itself faces the predicament I have asserted confronts the Caribbean.
It too finds itself caught between two worlds; one that is no longer relevant and the other that is struggling to be born.
The changing nature of the IMF. Caribbean countries which enter programmes in this era with the IMF will find that they will have to relate to an institution that interprets its purpose as being in large measure very different from that at its conception, and which will engage in the application of programmes whose contents have been shaped by evolving experience and changing global requirements.
The IMF was created immediately after the Second World War not to be concerned with growth and development. It was created to manage stability. It was to exercise surveillance over a global economy in which member states had fixed exchange rates, to provide liquidity as necessary to maintain stability, and to intervene where member states experienced fundamental disequilibrium in their external position that was deemed to be of a temporary nature.
The financial policies of the IMF were derived from a theoretical approach developed by J.J. Polak, which held that balance of payments problems were caused by monetary factors, specifically by excessive domestic credit creation.
To that extent such problems had to be addressed by a country’s pursuit of policies, which required it to remove the things that were causing the excessive creation of domestic credit in the first instance, and to manage and if necessary suppress demand until the stresses subsided.
Beginning in 1952, relationships between countries experiencing balance of payments problems and the IMF came to take the form largely of standby arrangements, whereby in return for financial support, the countries undertook to remove the causes of problems as judged by the theory guiding the fund’s behaviour. Hence, the Fund’s policies generally contained tests to be passed regarding the net domestic assets of the financial system, the size of the deficit of the government and such related matters in search of the stabilization of the country’s external position . . . .
It is very difficult to contemplate how the typical micro economy of the Caribbean, whose output accounts for less than 0.001 per cent of global activity, could ever do anything to injure global economic activity. But a lot of policies required by the Fund to be followed in receipt of its funds have been accompanied by the requirement that countries should not impose restrictions on imports, for example, in pursuit of the mandate that its funds should not be used to support activity that might injure global prosperity . . . .
The nature of the Fund’s programmes has evolved over time in part because its clients have changed. Its original clients were the major industrialized countries seeking assistance to carry out stabilization programmes of which the last was the United Kingdom in 1968.
As its clientele has broadened to include new developing independent countries, the policies and the programmes of the Fund have evolved to accommodate, in large measure, the type of environment within which they are intended to be applied.
But until recently (2009), the Fund had retained its essential character by seeking to apply a one-cap-fits all approach, and by the use of quantitative targets which had to be applied based on a narrow monetarist view
of the world, which has invariably done more harm than good.
Its approach and that of the World Bank has hence been subject to strong, legitimate criticism, none better expressed than that which fell from the lips of the Right Excellent Errol Barrow at a World Bank/IMF meeting in 1974.
He said on that occasion: “Like most bureaucracies, the bank has developed its own theology with accompanying rituals of canons and liturgy and its own hierarchy of saints and priests and novices. We, the governors, are expected to attend the celebration of the mass on the saints days which usually extend over the last week in September and the first week in October dependent, for all intents and purposes, on the phases of the moon.
“We of the Caribbean are not classified by this or by any other international institution among the congregation of the absolute poor. Our countries do not figure among those selected for redemption, because we have managed by our own efforts to raise the per capita incomes of our people, and because we have succeeded in developing our health and education services to levels which frequently equate and sometimes surpass those of more prosperous countries.
“I speak for the median minority; for those hitherto silent members who have come out of the great tribulations, of those who are still members of the confraternity of pain and deprivation. We come from the Caribbean not as supplicants at the gate . . . .”
In response to legitimate concerns such as this, but without losing its essential focus, the IMF has evolved and survived by taking a more flexible and accommodating approach to the design of its programmes. It has also effectively sought to become a quasi-developmental institution by venturing into areas such as poverty reduction and by providing support for countries facing exogenous and natural disaster shocks.
Over the years it has sought also to try to respond to the peculiar circumstances of individual countries by front-loading the provision of its financing and functioning more as a crisis manager.
In all of this, over the years, its approach and ethos although modified, were not changed as regards their essential features. Countries still had to pass quantitative targets, set upfront, to gain access to the financing being provided by the Fund. At the
core of its programme also were a set of measures to compress demand, to curb the size of fiscal deficits and to liberalize the functioning of the economies concerned.
And the essential purpose of the programme continued to be dominated by the focus to establish conditions for the emergence of a sound balance of payments.
Caribbean countries have related to the IMF, in the context of such programmes, with mixed results. The extreme case is that of Jamaica which, between 1979 and 1996, operated largely under uninterrupted IMF support under six Standby Agreements and three Extended Fund Agreements. Some would argue in fact that Jamaica was to some extent used as a guinea pig for the variation in the IMF relations with developing
countries. The bottom line however is that its extended relationship with the Fund did not succeed in enabling Jamaica to overcome its major social and economic problems.
The new approach. A new approach to the IMF relationship with its borrowing members was launched in 2009 with the coming into being of the Flexible Credit Line.
Significantly, in its fact sheet on this new arrangement, the IMF clearly states that one of the key objectives of the new lending arrangement is “to reduce the perceived stigma of borrowing from the Fund, and to encourage countries to seek assistance before they face a full blown crisis”.
The Flexible Credit Line was designed to meet the demand for crisis prevention and crisis mitigation lending to countries facing a cash crunch and unsustainable debt positions. It was to be flexible to the extent that it was to be designed by the countries concerned, based on their perceived and articulated needs, as expressed in a homegrown programme for fiscal and structural reform, rather than conform to the dictates of the long-standing standard programme of the Fund.
Essentially, this means that countries’ relationship with the Fund would now be based, not as in the past, or having to meet preset quantitative tests, but on their presentation of a policy framework, devised by the countries themselves, that expresses a clear determination on their part to carry out strong reforms, and to build strong economic fundamentals as the foundations on which to rest such reforms.
The Flexible Credit Line would be designed to assure qualified countries of large and upfront access to IMF resources, with no ongoing conditions, but based on the strength of policy framework to which the country committed in advance.
Qualified countries would also enjoy the flexibility to draw on the credit line at any time within a pre-specified period or to treat it as a precautionary instrument. The countries need for IMF resources would be assessed and determined on a case by case basis.
The essence of all this is that a country’s access to IMF resources would be determined on evidence that it is a strong performer, or is committed to becoming a strong performer, and is resolutely committed to maintaining strong policies to bring about fiscal and financial stabilities and to support structural reform into the future.
In addition to a very positive assessment of the country’s policies as represented in its most recent Article IV consultations, the IMF has explicitly stated that the criteria to be used to assess a country’s qualification for such a Flexible Credit Line, under a Standby Arrangement, or an Extended Fund Facility, such as it is now in operation in Grenada and Jamaica, are:
A sustainable external position;
A capital account dominated by private inflows rather than official borrowing;
A track record of steady sovereign access to international capital markets at favourable terms;
If the arrangement is requested on a precautionary basis, a reserve position that remains relatively comfortable;
Sound public finance, including a sustainable debt position;
Low and stable inflation;
A sound financial system and the absence of solvency problems that could threaten the stability of the financial system;
The effective supervision of the financial sector; and
High levels of integrity and transparency in the publication of economic and financial data . . . .
A country seeking access to such a Flexible Credit Line has to build into its programme, quantitative performance criteria and indicative targets, especially in respect of the measures its proposes to introduce to restore soundness to its public finances and debt. It has to apply and accompany these by a structural reform programme that is intended to spell out how it proposes to create stronger conditions for growth and development.
And these are made subject to certain monitoring arrangements to ensure that the programme is kept on track and its purposes met and sustained.
Grenada is to benefit from the application of such a Flexible Credit Line approach under its Extend Fund Facility Loan with the Fund. Its arrangement with the Fund its based on its own Poverty Reduction And Growth Strategy which importantly seeks to bring together, to be executed as one coherent undertaking, policies and programmes to stabilize the economy, correct fiscal and debt imbalances, stimulate growth and transformation, reduce poverty and strengthen the social safety net over a predictable planning period.
It is an enormous and complex undertaking that has about it aspects and actions that just simply have to be done, but will take heroic effort to achieve.
I offer the following observations not to condemn, especially since the execution of this new type of IMF programme is really based in large measure on what a country simply has no choice but to do, recognizing that it will require great sacrifice and discipline, and may cause some pain in the process.
For, as Ovid said, there is no excellence without difficulty.
First, it must be recognized that the arrangement with the Fund is not intended to provide Grenada with the financial resources to finance its way out of the debt and crash crunch crisis that is faces.
It is a US$21 million programme.
If evaluated within the context of what it will take to make the government solvent, and attain a sound debt position, the financial body of the programme can be said to be scantily clad.
The IMF funding alone cannot stabilize the Grenadian economy.
There should therefore be no doubt that the resources to bring about the fiscal stability sought will have to come from the success of measures by the government itself to generate more revenues, measures to curb its spending, and secure fiscal space through the significant debt restructuring it proposes to undertake as part of its fiscal consolidation programme . . . .
And in the absence of strong growth, the fiscal targets themselves will be hard to attain.
Ideally therefore, the fiscal consolidation programme should go hand in hand with the growth programme . . . .
There can therefore only be a successful overall happy ending, if the programme of structural reforms intended to create the conditions for stronger growth, generate stronger positive effects and outcomes to more than offset the economic drag that fiscal consolidation programmes will lead to.
This raises the second consideration. The IMF is not financing stabilization in full.
Nor is it a development finance institution in a position to finance development or structural reforms, such as contained in the Grenada programme.
The resources to carry out the structural and institutional reform spelt out in the programs that are deemed to be necessary to generate growth, will therefore have to come from other institutions and agencies with whom the government relates.
The IMF policies will therefore only lead to success if they function as a catalyst, and by serving as the seal of approval, unlocks Grenada’s access to sources of development financing that would otherwise not be forthcoming.
The success of the IMF programme therefore will depend more on what it triggers as a catalyst, and less or what it provides for in and of itself.
Third, a large proportion of the measures set out as structural reform programmes will entail significant changes to existing legislation, the introduction of new ones and major new institutional arrangements of far-reaching consequence.
It will amount almost to having to change an entire economic culture.
In this respect, it is relatively easy for Government to change economic policies by fiat through adjusting taxes and expenditure.
It is rather more difficult to induce change by having to adjust a large number of existing laws or to introduce new ones.
Legal drafting deficiencies that are so often inherent in small states can be as much a constraint to the implementation of a programme of structural reform, as the fiscal constraint.
Related to this, the design of the new Flexible Credit Lines programmes is based on the presumption that a country can gain a “good governance dividend” by implementing new arrangements to encourage greater transparency and accountability in its affairs.
This cannot be gain said.
Continued here: No success without pain.