A quarterly magazine of the IMF

March 2001, Volume 38, Number 1

Recent financial crises and the growing income gap between rich and poor countries have fueled intense criticism of today's global economic and financial system. Much of this criticism is directed at the IMF, the World Bank, and the World Trade Organization (WTO), institutions perceived as promoting the policies that have led to unprecedented (and still rapidly growing) levels of international trade, capital flows, technology spillovers, information exchanges, and cross-cultural influences—in short, globalization.

The demonstrations organized around the WTO's meeting in Seattle in 1999 and the IMF-World Bank meetings in Washington, D.C., and Prague in 2000 underscored concerns about globalization. It would be a mistake simply to dismiss the protesters as a fringe group of activists at the extremes of the political spectrum. Although radical groups were involved in some of the protests, unease about globalization is fairly widespread in developed and developing economies alike.

The IMF is responding to questions about its role in today's world economy by reaching out to civil society at large and to nongovernmental organizations (NGOs) in particular. It has met demands for greater transparency by making detailed information about its operations and policies available on its external website (www.imf.org), and it seeks an open and ongoing dialogue with its critics, both to hear their views and to deepen understanding of both the benefits and the risks of open markets.

As we address the legitimate concerns of our critics and seek to dispel misunderstandings about globalization, we must admit that we cannot always predict the implications of changes in the rapidly evolving global economic and financial environment. We do know, however, that institutions and policies will need to adapt to cope with the challenges posed by globalization. This is particularly true for financial markets, which have grown dramatically, both in size and in sophistication. As financial resources are put to better uses within countries and across borders, there is considerable potential for gains in productivity and living standards. But there is also the potential for devastating financial crises like those that rocked emerging markets in 1997-98.

We must also acknowledge that globalization benefits people unevenly. It produces losers as well as winners. This is not new: history is full of examples of technological developments and rapid economic changes that benefited society as a whole while hurting some individuals or groups. But we can and should take measures to ease the pain. And, when economic changes have a significant and growing international dimension, we need not only appropriate national policies but also well-functioning global economic and financial institutions and internationally agreed rules and regulations.

Globalization and poverty

A rallying point for many critics of today's global economy and of the IMF is that while the advanced countries are becoming more and more prosperous, extreme poverty remains prevalent in many parts of the world. Many critics believe that globalization is somehow responsible for the plight of the poor. There is a widespread perception that the poorest countries' efforts to become better integrated with the world economy through trade liberalization and other market-oriented reforms (some would say under pressure from the industrial countries and the international financial institutions) have widened the gap in incomes between the developed and developing countries as well as between rich and poor within the same country. Many critics have characterized globalization as a race to the bottom in which the free play of market forces drives wages and labor standards in the poorest countries even lower as the latter attempt to attract foreign investment. Based on this line of reasoning, it is tempting to conclude—as many northern antiglobalization activists with a protectionist agenda have done—that trade should be restricted. Some critics even question the benefits for the poor of policies aimed at stimulating economic growth.

The notion that trade and economic growth aggravate poverty is unfounded, however. Experience has confirmed time and again that trade generally benefits the poor, by forcing economies to become more efficient and boosting growth, which are key to raising living standards. Trade liberalization has had huge benefits for countries as diverse as Finland, France, Mexico, Portugal, Singapore, Thailand, and Turkey; the poorest countries should have the same opportunity to benefit from open markets.

Conversely, restrictive trade policies tend to dampen productivity and growth and worsen conditions for the poor. We need only point to the disastrous economic and social effects of protectionist trade policies during the 1930s and to Latin America's unsuccessful experiment with inward-looking trade policies that contributed to the economic problems of the "lost decade" of the 1980s. Although protectionist policies may appear successful at first, they invariably breed inefficiency and are eventually abandoned, sometimes under duress.

Instead of questioning the benefits of free trade, those who are genuinely concerned about the poorest countries should campaign for the advanced economies to open their markets to developing countries' exports and to eliminate agricultural export subsidies. In fact, these reforms would be in the interests of the advanced economies themselves, even if other ways to support rural incomes would need to be found. Although many NGOs agree on the need for developing countries to increase their access to markets in the industrial countries, some of them, along with many antiglobalization activists, see trade as part of the problem rather than as part of the solution.

Similarly, some NGOs are highly critical of foreign direct investment, especially when undertaken by multinational enterprises, which are often perceived as exploitative. However, despite occasional unfortunate instances of unethical behavior, multinationals seem increasingly willing to respect internationally agreed principles regarding environmental protection and the abolition of child labor. And they generally pay higher wages than local employers do. Moreover, foreign direct investment is not only a critical source of management know-how but also promotes foreign trade, stimulates growth, and creates jobs.

Although free trade and foreign direct investment are part of the solution to the poor countries' problems, their benefits do not necessarily accrue to the neediest individuals. External and domestic liberalization therefore needs to be complemented by reforms aimed at improving the living conditions of the poor—such as policies that favor basic education, health care, and infrastructure; strengthen incentives for entrepreneurship and job creation; and combat corruption.

The debt burden

The IMF has been pointing out for nearly two decades that the debt burdens of many poor countries are unsustainable and that debt relief is justified not only on humanitarian grounds but also on economic grounds, because it would strengthen incentives for governments to improve their policies and for enterprises to invest by ensuring that the returns would flow to the country itself rather than to its foreign creditors. On this point, the IMF and the NGOs are in full agreement.

Differences of opinion remain, however, with respect to the conditions attached to debt relief. Many NGOs call for immediate, unconditional debt cancellation on humanitarian grounds. Although we share the concerns behind this demand, we would argue that debt relief is not an end in itself but a means to an end, the true objectives being durable poverty reduction and sustainable economic growth. Debt relief alone cannot deliver this, since the resources it would make available to poor countries may be wasted. If appropriate conditions are not attached to debt relief, the benefits for the poor might be trivial and short-lived, while the prospects for a country's return to creditworthiness would remain dim. It is in the best interests of both creditors and debtors that debt relief occur as swiftly as possible in combination with serious efforts to tackle the problems that contributed to the accumulation of excessive debt in the first place.

For the heavily indebted poor countries (HIPCs), the enhanced HIPC Initiative launched by the IMF and the World Bank in 1999 is central to the efforts of the international community to establish a virtuous circle of debt relief and poverty reduction. The initiative will enable the international community to deliver faster, broader, and deeper debt relief and to ensure that the released funds are channeled toward antipoverty programs. A key aspect of the IMF's Poverty Reduction and Growth Facility (PRGF)—a vehicle for providing concessional assistance to low-income countries—as well as of the financial assistance provided by the World Bank and other creditors and donors is that the countries themselves, in consultation with civil society, should develop poverty reduction strategies. As of January 1, 2001, 34 low-income countries were receiving financing through the PRGF, 22 of which had become eligible for debt relief under the enhanced HIPC Initiative.

The adjustment controversy

A key objective of the HIPC Initiative is to strengthen countries' "ownership" of their reform programs by involving civil society, so as to ensure reforms are implemented and achieve solid results.

Unfortunately, many of the broader reforms countries need to undertake if they are to reap the benefits of debt reduction and boost economic growth are criticized by NGOs. This criticism is not directed primarily at the need for macroeconomic stability that the IMF promotes, which the NGOs increasingly accept as being necessary for fostering sustained growth. Indeed, the proposition that large budget deficits and high inflation rates are likely to hurt the poor is widely accepted today.

Instead, the criticism is directed mainly at so-called structural adjustment programs, which are blamed for many of the problems faced by the poor in developing countries. These programs are widely but erroneously believed to require cuts in social spending, thereby making the poor even worse off than before. The privatization schemes they often include are thought to deprive poor countries of their natural resources and wealth to the benefit of multinational enterprises. Structural adjustment programs are also viewed as forcing countries to devalue their currencies, thereby raising the prices of basic necessities and further impoverishing the poor, and as creating difficulties for smaller enterprises because of the higher interest rates that can result from credit market reforms. Finally, they are believed to encourage countries to increase commodity exports, driving down commodity prices and exacerbating environmental problems.

The IMF is fully conscious of the problems that may be associated with unduly rapid or overly detailed structural adjustment programs. Countries are unlikely to feel a sense of ownership of programs that stretch their capacity for implementation and, as a result, may lack the political will needed to carry them out. These concerns are reflected in the HIPC Initiative, which seeks to promote domestic ownership by involving NGOs locally in assessing the need for, and the impact of, reforms. Of course, it is for the countries themselves to decide how best to involve civil society.

We remain convinced, however, that strengthening economic incentives through greater reliance on market forces instead of through administrative decisions (which tend to encourage rent seeking and corruption) is essential to improving the economic performance of the poorest countries. To this end, the effective implementation of well-sequenced structural reforms is indispensable. Of course, the reforms need to be designed with great care to minimize adverse social and environmental consequences, and countries should have social safety nets in place to protect the most vulnerable groups.

In fact, the IMF's critics are patently wrong when they claim that IMF programs force countries to cut spending on social programs. The reality is that the IMF routinely emphasizes the importance of sustaining or even increasing expenditures on health care and education while advising countries facing budgetary pressures to cut back unproductive spending (for example, on the military, on subsidies for the well-to-do, and on salaries for a bloated civil service). The record is clear: in 60 countries that had IMF programs between 1985 and 1998, per capita spending on health and education rose by more than 2 percent a year, after inflation.

Moreover, there are strong indications that economic performance has improved in countries that have steadfastly pursued structural adjustment programs. In sub-Saharan African countries with IMF-supported reform programs, for example, average annual output growth increased from just 1 percent in 1992-94 to 4-4¹/2 percent in 1998-99. Since 1987 (and until very recently, when natural disasters had a devastating effect on Mozambique), cumulative gains in real per capita incomes in Mozambique and Uganda—two relatively consistent reformers—have been large, at more than 30 and 40 percent, respectively. Since its balance of payments crisis in 1991, India has registered a rapid turnaround in growth, largely because of structural reforms. Per capita growth has averaged well over 4 percent a year since the mid-1990s, compared with 1.5 percent a year during the three decades following independence in 1947, when the Indian economy was stifled by regulation.

Critics often argue that poverty levels have increased in some countries undertaking structural reforms, and this is held up as proof that reforms have failed. In our view, however, what this shows is that growth needs to be even faster and that programs designed to boost growth rates have to be oriented toward dispersing the benefits of growth to the poor. What the critics of reforms also forget is that poverty levels would have been even higher in the absence of structural reforms.

Many other issues come up frequently in our dialogue with NGOs, including the political legitimacy and accountability of the IMF. The NGOs argue that the developing countries should be given a greater say in the IMF's policies and operations, while that of the finance ministries whose influence they consider excessive should be reduced. Such questions need to be discussed by our member countries. The NGOs also frequently ask the IMF to support the Tobin tax—a tax on speculative capital flows. Our answer is that it is impossible to distinguish speculative flows from other flows. Moreover, such a tax would require universal agreement, which does not seem very likely, and we remain skeptical about the tax's ability to prevent speculative attacks. We believe it would be better for countries to concentrate on strengthening their resilience to potential destabilizing swings in market sentiment through strong financial policies, consistent macroeconomic and exchange rate policies, and robust financial systems.

Flemming Larsen is Director of the IMF's Office in Europe.