Conditionality and the International Monetary Fund Mandate Finance Essay

In the primary Articles of the Agreement of the International Monetary Fund (IMF) which set up the Fund in July 1944 neither the term structural adjustment nor the term conditionality can be found [1] . Conditionality was explicitly incorporated into the IMF when the Articles of Agreement were amended in 1968 [2] . Henceforward Article V Section 3 states that "The Fund shall adopt policies on the use of its general resources, including policies on stand-by or similar arrangements, and may adopt special policies for special balance of payments problems, that will assist members to solve their balance of payments problems".

However, even before conditionality was explicit in the IMF mandate the Fund used to practice a sort of conditionality from its beginning. For instance, after the IMF made its first loan to France in 1947, they refused another loan for France in 1948 because the Fund did not accept the French exchange rate policies [3] . But also in the early years conditionality was officially announced and "Stand-by Arrangements" were introduced by the Fund [4] . On February 13th 1952 the Executive Board decided that Fund resources should be used to help members provided "the policies the members will pursue will be adequate to overcome the problem" [5] . However, in the early years conditions were fewer in number and less detailed whereby this policy has come to be called "macro-conditionality". Usually these conditions included cutting the government budget deficit, reducing the money supply and sometimes the devaluation of the national currency [6] . Although the Fund configured the essential policy, governments had a lot of room in how they could achieve the macro-economic targets of IMF arrangements [7] . The rationality of conditionality is to prevent the possibility of what economists call a "moral hazard" [8] . Moral hazard occurs when a party insulated from risk may behave differently than it would behave if it were fully exposed to the risk. Because IMF loans can be seen as a sort of insurance against the risk of a balance of payments crisis a moral hazard could occur when governments know that the insurance entity - here the IMF - will pay in any event, even if they operate an irresponsible economic policy.

As in 1982 a deep financial crisis arose in Latin America due to excessive public sector borrowing the IMF was faced with considerable critics because countries of this region had participated in more IMF programmes than any other in the world [9] . The official IMF response was that not the general policy was wrong but that the programs had not gone deep enough. Thus, the IMF began to enforce more detailed policies which not only include fiscal and monetary targets, but also targets for international reserves, limitations of foreign debt, a prohibition against import restrictions, further provisions for trade liberalization, as well as conditions calling for privatization and deregulation of labour laws [10] . Therefore the Fund not only said that the balance has to be restored but moreover, how the government has to react specifically. This level of detail of IMF programme conditions is also called "structural adjustment" or "micro-conditionality" [11] . Polak (1991) analyses that the average number of conditions increased from below six in the late 1960s, to seven in the late 1970s to over nine in the late 1980s [12] . Then, as Bird reports, the average number of conditions per IMF arrangements increased to 9.9 in 1993, 10.5 in 1994, 11 in 1995, 13.0 in 1996 and 16 in 1997 [13] . So over time, the policy conditions contained in IMF arrangements became much more specific [14] .

But also the "micro-conditional" policy came under attack in the aftermath of the East Asian financial crisis which started in 1997 and attached nearly every county in this region [15] . Commentators pointed out that IMF conditionality had gone too far in the opposite direction of macro-conditionality and were too specific [16] . Interestingly the response of the Fund this time was a reversal of the trend backwards to a reduced conditionality again. The IMF uses the term "ownership" which means that participating countries should take more part in elaborating and implementing the conditions [17] .

Despite the changes the IMF has made in defining conditionality since its beginning the basic approach to economic problems has not changed. The Fund still includes conditions which intend to lower the consumption of imported goods and thus, the arrangements require governments to reduce public spending, raise interest rates and taxes or devaluing the domestic currency in order to raise the prices of imports and make exports more competitive [18] . Therefore conditionality is still controversial and the question is if the IMF policy of conditionality needs further changes. To answer this question it is essential to examine what the effects of IMF conditionality are. From this result a conclusion may be drawn to what extent IMF policy should be modified.

2. Effects of IMF programmes

There is a huge amount of data about the IMF programme since the 1950s. In total the official data from the Fund covers 199 countries for a total of 1,132 observations to date [19] . In theory there should be a clear picture about the effectiveness of IMF programmes, but despite the wealth of data researchers have found different results. The reason is mainly that different statistical approaches were used in the studies and their choice is often contended [20] . Nevertheless, there exist remarkable studies about the impact of IMF programmes on various parameters. Important indicators are balance of payments, inflation, budget deficits economic growth, income distribution and social spending.

a. Effects on the balance of payments

According to the Articles of Agreement one of the most important tasks of the IMF is it to help members solving problems in their balance of payments [21] . Deficits in the balance of payment arise when a country is taking in more imports or fixed assets or capital than it is generating through exports [22] . The IMF tries with its conditional loan to cut the domestic demand for imports and foreign finance in order to adjust the balance of payments through the mechanisms previously discussed.

Pastor (1987) examined the impact of IMF programmes in Latin American countries in the period from 1965 to 1981 [23] . He found a statistically significant positive effect of IMF conditional loans on the balance of payments. Killick et al. (1992) also noticed in their study about the participation of Latin American countries in IMF programmes a statistically significant positive impact on the balance of payments [24] . In an extensive study of 69 countries from 1973 to 1987 Gylfason (1987) also found a statistically significant positive effect of IMF programmes on the balance of payments [25] . Khan came to the same result in his study from 1990 [26] and Conway (1994) in his paper which observed 74 countries from 1976 to 1986 [27] . The only study which actually found a negative impact was conducted by IMF economists Goldstein and Montiel (1986) [28] . So the majority of studies using various methods and data have found that IMF programmes have a positive effect on the balance of payments.

b. Effects on inflation and budget deficits

According to the IMF, fiscal adjustment and stable prices are one of the core elements of macroeconomic design in IMF programmes [29] . Killick et al. (1992) as well as Conway have found that IMF programmes have a statistically significant positive effect on the budget deficit. Steinwand and Stone (2008) reviewed 22 studies on the relationship between inflation and IMF programmes [30] . However, his review does not provide a clear picture. Six studies found no effect, ten studies report that inflation decreases but without a statistically significant effect. Three studies in the review noticed a statistically significant negative effect, and three studies report that inflation increases, even if the effect is not statistically significant. The result implies that either IMF conditionality does not effectively address inflation or governments fail to comply with the conditions of the IMF. Also a combination of both options seems possible.

c. Effects on economic growth

Although economic growth is not explicit stated in the IMF Agreement [31] the IMF regards economic growth as a key goal of its policy [32] . The First Annual Meeting of the Board of Governors in 1946 already defined growth as a function of the fund when they declared that the Fund should "aid members in maintaining arrangements that promote the balanced expansion of international trade and investment and this way contribute to the maintenance of high levels of employment and real income" [33] . But there is only weak evidence that the IMF has been successful in promoting the growth of the participating country. A review on early studies about the impact of IMF programmes on economic growth was published by the IMF in 2001 [34] . Out of nine studies from 1978 to 1995 covering different countries, regions, and programme-lengths, only one reported a significant positive effect. Four studies have found no effect; two reported a statistically insignificant effect and one reported an insignificant effect. Recent studies even show that IMF conditionality programmes have a significant negative effect on economic growth. This is result is supported by studies from Kahn (1990) [35] , Conway (1994) [36] , Dicks-Mireaux et al. (2000) [37] , Przeworski and Vreeland (2000) [38] , Hutchison et al. (2003) [39] and Dreher (2006) [40] . Thus, the newly emerging scientific consensus is that IMF programmes hurt economic growth.

d. Income distribution and social spending

An Evaluation Report from 2003 published by the IMF Independent Evaluation Office (IEO) considered 146 countries from 1985 to 2000 and examined how IMF programmes impact the poor, such as spending on health and education [41] . One result of the study was that governments not only did not cut such spending but the paper also indicates that IMF programmes let governments decide to increase their education and health budget An IEO study from 2004 confirmed this conclusion [42] . However, Nooruddin and Simmons (2006) found that while the overall effect of IMF programmes on health and education spending is positive, the impact is not statistically significant [43] . Moreover, the authors actually pointed out that for democratic countries the impact on health and education expenditures were negative.

Three studies deal with the question if IMF programmes increase income inequality. Despite using different methodologies and data they all came to the same result that IMF conditionality programmes have caused a rise in income inequality. In a study about the income in Latin America under IMF programmes between 1965 and 1981 Pastor (1987) concluded that "the single most consistent effect the IMF seems to have is the redistribution of income away from workers" [44] . In a cross country analysis also Garuda (2000) found that IMF programmes exacerbate income inequality [45] . To the same conclusion came Vreeland (2002) who looked at the earnings in the manufacturing sector of 110 participating countries from 1961 to 1993 [46] .

3. Changes to IMF policies

As the mentioned studies show IMF conditional programmes do not have the success they should have. Therefore it seems to be necessary to think about how the IMF can achieve better results. One well-known critic is Nobel Prize laureate and former chief economist and senior vice president at the World Bank Joseph Stiglitz. In his view the major problem that the IMF failed in so many cases is its conditionality policy. The IMF recipe of liberalisation, deregulation and fiscal austerity is counterproductive because under economic crisis such policy can increase unemployment and deepen the crisis [47] . Stiglitz also points out that an industrialised country which is faced with an economic crisis do exactly the opposite of the conditionality policy which the IMF claims from its supported countries. So for example when the United States faced an economic downturn in 2001, "the debate was not whether there should be a stimulus package, but its design" [48] . Siglitz's standpoint is supported by the reaction of the G-8 states to the current financial and economic crisis. In order to soften the biggest recession in the world since the Great Depression nearly every country has set up an enormous stimulus programme and governments as well as central banks accepted a rapidly increasing budget as well as the danger of high inflation due to a monetary policy of quantitative easing which finally means printing money without an economic growth. Under IMF conditionality such programmes would be unimaginable. Stiglitz concludes that the IMF probably acts more on the behalf of foreign investors and domestic elites at the expense of the poor than following economic rationality [49] . Stiglitz argues the IMF conditionality should be reduced and the Fund should return to the mandate proposed by Keynes: "providing funds to restore aggregate demand in countries facing economic recession" [50] . However, others authors like Thomas Willet [51] argue that the reason for disappointing results of the IMF policy is not the conditionality itself but rather the problem has been one of compliance. If participating countries would comply more with the IMF conditions, the results would also improve. International governmental policies as well as the IMF itself should enforce the conditions set by the IMF more strictly. Vreeland points out that the US often prevents the IMF from enforcing conditionality if these countries are favoured by the US for political reasons [52] . Even the Fund reacts to critics of its policies and has adapted its policy accordingly over time. It seems like the IMF is stuck in a battle between opposing viewpoints on conditionality. Perhaps, such problems are unavoidable for a global financial institution like the IMF but nevertheless it is obvious that conditionality is abused either by countries which are not interested in enforcing it or by countries which are not interested in a stable economic and social policy because they rely on a guaranteed IMF bailout.

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