Can The U.S. Save The World?

Yesterday I testified to the House Subcommittee on International Monetary Policy and Trade (part of the House Financial Services Committee). The hearing’s title was “Implications of the G-20 Leaders Summit for Low Income Countries and the Global Economy,” and the main topic was whether Congress should support an extra $100bn for the IMF that the Obama Administration agreed at the G20 summit in early April (witness list, webcast, and written testimony).

The committee was mostly in favor of the US continuing to play a leading role in supporting the IMF, but pressed the witnesses to explain whether the IMF could lose this money (highly unlikely), how this would protect American jobs (definitely, but hard to quantify precisely), and if the broader package of IMF reform should also be supported (e.g., the proposed gold sales are being reassessed, to see they could generate more resources for aid to developing countries).

Politico is reporting that US funding for the IMF is likely to be attached to the war supplemental spending bill. The subcommittee’s chairman, Gregory Meeks, seemed positive – as did all the Democrats who spoke, along with Gary Miller, the Ranking Member/Senior Republican. But, based on remarks made by at least two Republican members of the subcommittee, there is likely to be a big public fight at some point. My guess is that the Democratic side will press hard for President Obama to more publicly explain why supporting the IMF (and the G20) is very much in the US interest.

The main points from my written testimony are below. While Treasury represents the US vis-a-vis the IMF and traditionally has considerable scope for action, the views of Congress on IMF details are very important as both guidance and constraints. In our advice on the wide range of IMF-related issues below, both I and the other witnesses laid out broadly similar views with varying emphasis – there was actually much more disagreement among committee members than at the witness table.

Main points

Low income countries have been severely affected by the global economic downturn. Many of the worst consequences, including on the poorest people, have yet to be felt.

In that context, by contributing to the stabilization of the world’s financial system, the G-20 summit had a positive effect. However, it left open a large number of important issues, some of which call for immediate congressional attention.

First and foremost, low income countries need to receive considerable additional resources in order to weather the crisis. This crisis is not of their making and, prior to this shock, poorer countries were making considerable progress along the lines of implementing exactly the policies advised by richer countries and the International Monetary Fund (IMF).

The IMF has adapted its standard forms of conditionality to current circumstances. The goal of protecting core social spending is commendable and long overdue, and the implementation in recent East European and Pakistan programs is encouraging. However, the retreat from structural conditionality has probably gone too far and needs to be reappraised; the weaknesses of low income countries arise from and are manifest in disproportionate power of key individuals or sectors, and this needs to be addressed in a transparent manner wherever the IMF is engaged. In situations where such issues have been taken on board – as with transparency for extractive industries – the reception among civil society has been very positive.

The potential US legislative package (including IMF gold sales, its new income model, and $100 billion for the New Arrangements to Borrow) is worth serious consideration but also needs careful congressional review. The $250bn issue of Special Drawing Rights is a bold move which, while it involves some risks, is well worth taking – hopefully, this will be regarded as a pilot project for potentially larger increases in resources for troubled countries, on an “as needed” basis.

The G20 called for $6 billion of additional concessional resources from the Fund over the next 2-3 years for Low Income Countries, including some vague phrasing on money from gold sales. So far, the gold piece of this puzzle remains stalled at the level of the IMF’s executive board. More transparency around board discussions on this and other items would reveal who is holding up change and for what reason.

Providing additional resources to low income is a very good idea, and increasing the resource flow from and through the IMF is timely and appropriate. If these resources can come from “extra” proceeds from gold sales, that would be an attractive solution – particularly as the income model needs some adjustment in the light of (a) the increase in Fund lending over the past 12 months, and (b) the introduction of the Flexible Credit Line, which offers the promise of Fund revenue even during quiet times for the global economy. However, it is too early to determine how profoundly the Fund’s income model will be affected by this crisis and how the world responds.

As long as the Fund lends at concessional rates to low income countries (and the relevant, Poverty Reduction and Growth Facility interest rate is only 0.5% per year currently), loans may be attractive relative to grants – the key issue is the resource flow that is available, i.e., does lending allow more transfers in a meaningful and sustainable manner. Avoiding unsustainable debt burdens is of course of paramount importance.

Most important, we should take all available actions to shore up low income country defenses against this crisis. We should also guard against any form of complacency.

For that reason, it is most important that the IMF be authorized to restore its budget to its early 2008 level (i.e., before the 15-20% across the board cuts were implemented). Cutting the budget and letting go some of the most experienced IMF staff was the unfortunate result of gross macroeconomic negligence at the level of leading industrialized countries, including the US and its G7 partners. At the same time as the IMF was warning, clearly and firmly, that a global crisis was developing, major shareholders pushed through budget cuts that resulted in some of the IMF’s best people leaving the organization.

Undoing the budget cuts would be embarrassing to leading European countries, but it should fine support from the Obama Administration – after all, it was their idea to make increasing IMF resources a central issue at the recent G20 summit. The IMF simply does not currently have sufficient skilled staff to undertake all the important tasks it has been asked to handle.

The G20 summit effectively agreed to end the European monopoly on the position of Managing Director at the IMF. Since the summit, there has been some indication of backsliding on this issue, but assuming that European countries can be kept to their commitments, this would be a major step in the right direction. Given that the next leadership change is likely to take place in a little over a year, identifying and supporting sensible candidates from emerging markets would be most constructive. If an Indian or a Brazilian, for example, could be brought in as Managing Director, that has the potential to greatly expedite the rebuilding of the IMF’s legitimacy and its engagement throughout the developing world.

Unfortunately, IMF credibility has been somewhat damaged by its inability to follow through on exchange rate surveillance, particularly with regard to China. While there seems to be a movement towards implicit agreement among leading countries, in and around the G20, to take this issue of the table, that would be a serious mistake. Countries must not think that competitive devaluation (or even sustaining accidental undervaluation) is a sensible or attractive policy. This will lead to greater global imbalances and potential instability, as some countries compete to get current account surpluses and other countries – willingly or not – run deficits.

Unless and until countries are assured that there is an effective international lender of last resort, they will be tempted to try to accumulate large amounts of reserves. This creates problems for reserve currency countries (e.g., the United States) as well as for the global system as a whole. We need an international system that can handle these issues and prevent them from becoming destabilizing. The IMF should be given another chance to show that it can help run the global system in a constructive fashion. This is of paramount importance for the United States and for everyone who wants to participate in an open international trading system – particularly low income countries, which have few other opportunities to grow and which remain highly vulnerable to shocks of all kinds.

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