Debate on the International Monetary Fund INTERNATIONAL ...

3 downloads 240 Views 53KB Size Report
targets is founded on very little empirical evidence in the peer-reviewed literature. ... on time to private international creditors and lenders. Thus, its economic ...
Debate on the International Monetary Fund INTERNATIONAL MONETARY FUND SACRIFICES HIGHER GROWTH, EMPLOYMENT, SPENDING, AND PUBLIC INVESTMENT IN HEALTH SYSTEMS IN ORDER TO KEEP INFLATION UNNECESSARILY LOW Rick Rowden

The International Monetary Fund’s response to evidence on the impact of its programs on public health fails to address the fundamental criticisms about its policies. The IMF’s demand for borrowers to achieve extremely low inflation targets is founded on very little empirical evidence in the peer-reviewed literature. The low-inflation policies privilege international creditors over domestic debtors and short-term priorities over long-term development goals, and contain high social costs, referred to by economists as a “sacrifice ratio.” For example, governments’ raising of interest rates to bring down inflation undermines the ability of domestic firms to expand production and employment and thus “sacrifices” higher economic growth and higher tax revenues and unnecessarily constrains domestic health spending. During financial crisis, most countries seek to lower interest rates to stimulate the economy, the opposite of the IMF’s general advice. Perversely, compliance with IMF policies has become a prerequisite for receiving donor aid. Critiques of the IMF express significant concerns that IMF fiscal and monetary policies are unduly restrictive. Health advocates must weigh in on such matters and pressure their finance ministries, particularly in the G7, to take steps at the level of the IMF Executive Board to revisit and modify its policy framework on deficits and inflation. Such reforms are crucial to enable countries to generate more domestic resources while the global health community searches for ways to support strengthening health system capacity.

The International Monetary Fund (IMF) builds a straw-man argument by falsely mischaracterizing criticisms leveled against it, then easily knocks over such International Journal of Health Services, Volume 40, Number 2, Pages 333–338, 2010 © 2010, Baywood Publishing Co., Inc. doi: 10.2190/HS.40.2.n http://baywood.com

333

334

/ Rowden

arguments (see Gupta’s article in this Journal issue, p. 323). However, a more careful reading of claims by critics shows that the concern is not necessarily that the IMF always has a direct impact on health spending (although it can) but that, in fact, it often has several crucial but indirect impacts, many of which are long-term in nature. A fundamental problem is that the IMF is not a development organization per se, but acts as an enforcer to make sure sovereign debt payments are made on time to private international creditors and lenders. Thus, its economic policies for the borrowing countries are primarily designed for achieving this short-term priority to generate increased exports and earn foreign exchange with which to repay creditors. Whether or not such short-term priorities conflict with longerterm successful economic development strategies or health goals is not the priority of the IMF or its programs. Nevertheless, most bilateral and multilateral aid donors still look to the IMF for its pre-assessment of the adequacy or “soundness” of a recipient country’s macroeconomic policies before giving out foreign aid each year. In this way, aid donors have afforded tremendous leverage and power to the IMF to serve as the de facto head of a donor aid cartel. If the IMF were designed to prioritize development goals, that would be a different matter. But because it is not, this should be of grave concern to all who are concerned with development generally, and health outcomes specifically. At issue are two controversial IMF policies to keep inflation at or below 5 to 7 percent per year and to keep budget deficits below 3 percent of gross domestic product (GDP). These policies are based in the monetarist school of thought within neoclassical economics and have been in place since the early 1980s. While the IMF claims such restrictiveness is required for “macroeconomic stability,” this position is not supported by the peer-reviewed literature in economics. Because the main method used to lower inflation or keep it at such low levels is to raise interest rates, the concern over such policies is that their degree of restrictiveness undermines the ability of countries, and particularly domestic industries, to generate the higher levels of productive capacity, employment, and GDP output—and thus, tax revenues—that could be achieved under more expansionary fiscal and monetary policy options. This deprives governments of higher levels of tax revenue generation and available public expenditure for both recurrent expenditures and crucially, over time, long-term public investment as a percentage of GDP. This is because raising interest rates makes credit less affordable to both government and domestic companies; it prevents the government from engaging in more affordable deficit financing or public investment and prevents the domestic private sector from expanding production and employment—both of which carry long-term consequences for national budgets and health financing. As a major 2005 World Bank retrospective on economic growth concluded, the IMF’s effort to correct current account imbalances and lower inflation may well have come at the cost of unnecessarily lower tax revenue generation,

IMF Policy Keeps Inflation Unnecessarily Low

/ 335

multiplied over many years (1). This has contributed to the chronic mode of low growth, low employment, low spending, and insufficient public investment to finance the longer-term structural transformational processes of industrialization and economic diversification and development that has characterized developing countries for much of the past 30 years. The same concern had been clearly articulated in an earlier (2001) U.S. Government Accountability Office (GAO) report on IMF loans, when it cautioned: “Policies that are overly concerned with macroeconomic stability may turn out to be too austere, lowering economic growth from its optimal level and impeding progress on poverty reduction” (2). The IMF does not address this major criticism. It is important for readers to know that the IMF has very little empirical evidence in the economics literature to justify pushing inflation down to the 5 to 7 percent level, with the consequences of lower growth, lower taxes, and lower spending. This is often considered surprising, given the widespread belief that the IMF is the expert on such matters. While everyone agrees that high inflation is harmful and must be brought down, a false, black-or-white dichotomy has developed in which people believe that you must have either very low inflation or out-of-control hyperinflation, with a near total disregard for reasonable rates of moderate inflation that historically (before structural adjustment programs in the 1980s) had coexisted with high GDP growth rates in developing countries. A far more relevant question is, how low must inflation be brought down and at what level must it be maintained? At least nine major studies have examined this question and have tried to find the “kink” in the inflation–growth relationship, or the level at which inflation begins to hurt a country’s long-term GDP growth rates: 1. Fischer and Modigliani (3, 4) found the danger point for inflation to be between 15 and 30 percent. 2. Bruno (5) cited a major unpublished World Bank study of the link between inflation and economic growth in 127 countries from 1960 to 1992, which found that inflation rates below 20 percent had no obvious negative impacts on long-term economic growth rates. 3. Barro (6) found that an increase of 10 percentage points in the annual inflation rate is associated on impact with a decline of only 0.24 percentage points in the annual growth rate of GDP (but this does not justify the IMF’s restrictive disinflation policy targets). 4. Sarel (7) found the danger point for inflation at 8 percent. 5. Bruno and Easterly (8) found the danger point to be as high as 40 percent. 6. Ghosh and Phillips (9) found that the inflation–growth relationship is convex, so that the decline in growth associated with an increase from 10 to 20 percent inflation is much larger than that associated with moving from 40 to 50 percent inflation (but this does not justify the IMF’s disinflation policy targets).

336

/ Rowden

7. Khan and Senhadji (10) found the danger point for inflation at between 11 and 12 percent for developing countries and between 1 and 3 percent for industrialized countries. 8. Gylfason and Herbertsson (11) found the danger point for inflation at between 10 and 20 percent. 9. Pollin and Zhu (12) found the danger point to be between 14 and 16 percent (for middle- and low-income countries). Health advocates should know that what these nine major studies show is that not only are the estimates all over the place and further research still needed, but, as Pollin and Zhu note, “There is no justification for inflation-targeting policies as they are currently being practiced throughout the middle- and low-income countries” (12). The same literature was reviewed by the 2007 study from the Washington-based Center for Global Development (ironically, cited in the IMF’s response; see Gupta’s article, p. 323), which actually found: “Empirical evidence does not justify pushing inflation to these levels in low-income countries” (13), and by the House Financial Services Committee of the U.S. Congress, which wrote to the IMF in 2007: “We are concerned by the IMF’s adherence to overly-rigid macroeconomic targets”; and “It is particularly troubling to us that the IMF’s policy positions do not reflect any consensus view among economists on appropriate inflation targets” (14). The added significance of the research by Bruno and Easterly (8) and Fischer (4) is that Bruno was once the World Bank’s chief economist, and Fischer became the head of the IMF, so their research was coming from the heart of the establishment, so to speak. The very existence of papers like those of Bruno and Easterly and of Fischer suggests that even at the center of the IMF and the World Bank, the opinion on this issue is divided. Less ideological economists will acknowledge that the research is inconclusive. The 2008 Spence Commission on Growth and Development report also pointed to this specific concern: “Very high inflation is clearly damaging to investment and growth. Bringing inflation down is also very costly in terms of lost output and employment. But how high is very high? Some countries have grown for long periods with persistent inflation of 15–30 percent” (15). The report also quoted commission member Montek Singh Ahluwalia as noting: “The international financial institutions, the IMF in particular, have tended to see public investment as a short-term stabilization issue, and failed to grasp its long-term growth consequences. If low-income countries are stuck in a low-level equilibrium, then putting constraints on their infrastructure spending may ensure they never take off” (15). The key point to bear in mind is that, while the IMF and monetarists within neoliberal theory believe strongly that inflation must be driven so low, there are very real consequences and very important trade-offs being made behind closed doors when the finance ministries regularly agree to such low inflation

IMF Policy Keeps Inflation Unnecessarily Low

/ 337

targets in their loan arrangements with the IMF. Regarding the disinflation policies and the raising of interest rates to get inflation down, economists refer to the trade-off as the “sacrifice ratio”—or the amount of GDP growth (output) that is forgone, or sacrificed, to get inflation rates down to lower levels. Health advocates should look closely at what is being “sacrificed” when these targets are agreed upon: the lower growth means fewer taxes are collected and less public expenditure is available in future budgets. This carries huge social costs, and yet the costs of this approach, and the possibility of other policy options, are not subject to public debate, analysis, or consideration by any wider groups of stakeholders in the developing countries. There are competing formulas in the economics literature regarding how best to calculate the exact sacrifice ratio, including “Okun’s Law” and “Howitt’s Rule” (16–18). But whatever the formula, the IMF will not disclose how, or even if, it bothers to calculate the sacrifice ratio. Yet health advocates and others have a right to know the extent to which higher GDP output, employment, future tax revenues, and future public expenditures and investments for health are being foregone when signing on to such IMF loan program targets. As global aid donors take steps to assist developing countries with financing for health systems strengthening, it is expected that developing countries must also increase their own domestic contributions to increased health spending and investment in future years. But countries will not be able to generate significantly more domestic resources under the current IMF fiscal and monetary policies. Health advocates, particularly those in the rich countries, must take immediate steps to call on their finance ministries (such as the U.S. Treasury Department) to take steps at the IMF Executive Board to revisit and change these unnecessarily restrictive IMF policies, so that developing countries can better generate higher GDP output, employment, and tax revenues for increased long-term investments in rebuilding their health systems.

REFERENCES 1. World Bank. Economic Growth in the 1990s: Learning from a Decade of Reform. Washington, DC, 2005. www1.worldbank.org/prem/lessons1990s/chaps/frontmatter.pdf. 2. U.S. Government Accountability Office. Few Changes Evident in Design of New Lending Program for Poor Countries. Report to the Chairman, Committee on Foreign Relations, U.S. Senate. Washington, DC, 2001. 3. Fischer, S., and Modigliani, F. Toward an understanding of the real effects and costs of inflation. Weltwirtschaftliches Archiv. 114:810–833, 1975. 4. Fischer, S. The role of macroeconomic factors in growth. J. Monet. Econ. 32:45–66, 1993. 5. Bruno, M. Does inflation really lower growth? Financ. Dev. 32(3):35–38, 1995. 6. Barro, R. Inflation and economic growth. Fed. Reserve Bank St. Louis Rev. 78: 153–169, 1996.

338

/ Rowden

7. Sarel, M. Nonlinear effects of inflation on economic growth. IMF Staff Papers 43:199–215, 1996. 8. Bruno, M., and Easterly, W. Inflation crises and long-run growth. J. Monet. Econ. 41:3–26, 1998. 9. Ghosh, A., and Phillips, S. Warning: Inflation may be harmful to your growth. IMF Staff Papers 45:672–710, 1998. 10. Khan, M., and Senhadji, A. S. Threshold effects in the relation between inflation and growth. IMF Staff Papers 48:1–21, 2001. 11. Gylfason, T., and Herbertsson, T. T. Does inflation matter for growth? Jpn. World Econ. 13:405–428, 2001. 12. Pollin, R., and Zhu, A. Inflation and economic growth: A cross-country nonlinear analysis. J. Post-Keynesian Econ. 28(4):593–614, 2006. 13. Goldsborough, D. Does the IMF Constrain Health Spending in Poor Countries? Evidence and an Agenda for Action. Report of the Working Group on IMF Programs and Health Spending. Center for Global Development, Washington, DC, 2007. 14. House Financial Services Committee, U.S. Congress. Letter to the managing director of the IMF. Washington, DC. 2007. 15. Spence Commission on Growth and Development. The Growth Report: Strategies for Sustained Growth and Inclusive Development. Report of the Commission on Growth and Development. World Bank, Washington, DC, 2008. http://cgd.s3. amazonaws.com/GrowthReportComplete.pdf. 16. Thornton, D. The costs and benefits of price stability: An assessment of Howitt’s Rule. Fed. Reserve Bank St. Louis Rev. 78(2):23–38, 1996. http://research.stlouisfed.org/ publications/review/past/1996. 17. Ball, L. What determines the sacrifice ratio? In Monetary Policy, ed. G. Mankiw. University of Chicago Press, Chicago, 1994. 18. Cecchetti, S. What determines the sacrifice ratio? Comment. In Monetary Policy, ed. G. Mankiw. University of Chicago Press, Chicago, 1994.

Direct reprint requests to: Rick Rowden GDS–UNCTAD Palais des Nations CH–1211 Geneva 10 Switzerland [email protected]