The IMF and its influence on the Philippines

imf

(Lecture at Silliman University, February 2006.)

The IMF is not usually well understood. It is an international humanitarian institution, organized as a special agency of the United Nations. As such, its membership is restricted to countries. In other words, a private individual or corporation cannot be a member of the IMF.

It is an institution whose main product is economic advice. It is also an institution that lends money to governments, and borrowing governments have to follow IMF advice as a condition for eligibility to borrow from the IMF.

Background of BW Conference: Created just toward the end of WW II when the Allied countries were preparing for victory. Forty-five countries, including the Philippines, attended a conference at Bretton Woods, New Hampshire in 1944. There was an awareness that those who lost in the previous war, WW I, notably the Germans, were swayed by nationalist sentiments because of the harsh conditions imposed on them by the victors in that war. In a sense, the IMF associated extreme nationalism as a contributing factor towards war, and the IMF, as part of the UN, was charged with using economics as an instrument of peace.

Goals of the negotiators: Provide for monetary arrangements that would avoid the economic chaos of the interwar period that featured the Great Depression, exchange and trade restrictions as instruments of national policies, and exchange rate instability.

Conceptual design: Basic design of the IMF was a product of negotiations between the US Treasury and the British economist, John Maynard Keynes. To a large extent, the IMF is also a product of Keynesian economics.

Purposes of the IMF:

To ensure stable exchange rates by providing countries with advice and money to deal with their balance of payments problems. (Note: Money from the IMF is not free, it is lent at a low interest rate and must be repaid within a relatively short time).

Promote international monetary cooperation

Facilitate the growth of international trade

Promote convertibility of national currencies to foreign currencies

When it lends, it imposes conditions, to ensure that the moneys lent are not wasted. This is what is known in street demonstrations here in the Philippines as “IMF conditionality.” IMF conditionality is not different from what a lender normally expects of a borrower – i.e., to behave in such a way as to be able to repay.

How does it get its money? The member countries contribute gold, US dollars, or currency that can easily be converted into US dollars. In the 1940s, the world of money was pretty much still anchored on gold as the most basic form of money. Gold was demonetized in 1976, and now, the most common international money is US dollars or euros, the currency of most of the European countries today.

Normative economics

The IMF has its own ideas about what is good for mankind. These goals are pursued when the IMF imposes conditions when it lends money, or when it gives advice to those who don’t need to borrow:

Stable exchange rates are desirable.

So is full employment of labor and capital (Keynesian influence).

International trade, which is of course voluntary among countries, is favored because it benefits all countries, not just those who trade with each other. To achieve growth in international trade, the IMF requires countries to give its citizens freedom to acquire or sell foreign currency.

Positive economics

The IMF’s economists draw on their knowledge and understanding of how economies actually operate. It is acknowledged that this knowledge and understanding are not perfect. The main economic ideas accepted in the IMF as “conventional wisdom” are:

PPP Theory: PPP states that if you have inflation in the country, and no inflation abroad, sooner or later, the local currency will devalue.

Inflation is driven by monetary policy. If the government prints money beyond the amount desired by the domestic economy, there will be inflation.

Keynesian economics: If there is unemployment, it can be cured by government expenditure on public goods. When Keynes first proposed his solution to the Great Depression, he thought of government expenditures on public work projects, such as roads and other infrastructure. The Keynesian solution was tried for government expenditures for “transfers,” or for social welfare schemes to subsidize the poor. It turns out that using government expenditures to intervene in the markets for what are known as private goods (for example, education) does not easily reduce unemployment, usually because the rate of return in these goods is not all that high, as compared with the rate of return on public goods, such as infrastructure, that are normally in short supply.

Adam Smith’s market doctrine, which states that in many cases, the market provides the most efficient solution to the economic question of how goods are to be produced and distributed. The market concept is applied to goods that are internationally traded, and the moneys used to move such goods. In other words, if the government might decide that the market should be suppressed or regulated when it limits the freedom of individuals to buy and sell foreign currency. This government policy creates black markets as shortages of foreign currency and imported goods emerge. This form of government intervention results in economic inefficiency because it limits consumer choices. It also impedes the movement of world savings to areas where the return on investment is highest.

The theory of comparative advantage, attributed to the economist David Ricardo, is also relied upon by the IMF as the basis for its advice on the benefits of international trade. This theory states that even when a country is absolutely disadvantaged relative to another, it is still in its interest to engage in world trade by specializing in production that reflects its comparative advantage. For example, the Philippines may be at an absolute disadvantage relative to the U.S. in agriculture and medical services, because the productivity of the Filipino farmer and nurse is below that of their American counterparts. Nevertheless, it pays for the Philippines to sell medical services (by exporting nurses) and importing rice from the U.S. The reason is, of course, that the Philippine economy can produce more nurses relative to a given amount of rice given up, than the US economy can. This conclusion is of course very antagonistic to the usual nationalist sentiments we find in the Philippines, where the government thinks it “owns” Philippine labor, and it also thinks that importing food is necessarily a bad thing, so that it is a national goal to have self-sufficiency in rice production. Thus, the IMF can easily be seen as “insensitive” in its economic advice because it tells us that we are not quite rational, but rather sentimental about the trade-off between nurses and rice!

Combining normative and positive economics to explain IMF advice:

To achieve stable exchange rates, the IMF believes in the PPP theory. Therefore, the IMF will prescribe a low-inflation monetary policy. It tells governments not to print too much money. It will also ask countries to have only small government deficits, because typically, when the government deficit is large, the government is tempted to print money rather than to tax its citizens. When the government prints too much money, inflation emerges and the exchange rate, or the value of the local currency, falls.

To achieve full employment, the IMF uses conventional Keynesian economics, with the more recent realization that Keynesian prescriptions work only if government expenditure is sensible or efficient. It tells governments to look at the composition of government expenditure. It will tell governments not to put money into redistributive transfers, but into public goods. This explains why the IMF is often criticized for not having any compassion for the poor. The point is that Keynesian economics does not work if government expenditures are not directed towards productivity-enhancing public goods. If all the government did was to give money to the poor, the economy does not benefit, though of course the distribution of income and wealth is changed.

To facilitate the growth of international trade, the IMF tells countries not to impose restrictions on how citizens buy and sell foreign currencies. By avoiding such restrictions, the IMF believes that there will be greater choices for consumers on what goods they can buy, thereby improving their welfare. This policy recommendation is based not only on Adam Smith’s market doctrine but is also a straightforward application of Ricardo’s theory of comparative advantage.

 

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