IMF: The last generation of economic policies may have been a complete failure
Neoliberalism - which IMF researchers Jonathan Ostry, Prakash Loungani, and Davide Furceri loosely define as the opening of economies to foreign capital along with a reduction in government debt burdens - has been the dominant trend in economic policymaking over the last 30 or so years.
This broad framework for thinking about economic policy encourages increasing privatization of investment and a reduced capacity for government's to rack up debts in the pursuit of faster growth.
The policies of Ronald Reagan and Bill Clinton in the US, and Margaret Thatcher in the UK, are typically held up as the gold standards of neoliberalism at work.
But now it seems some at the IMF aren't so sure this tradition is all it's been cracked up to be. In their paper, Ostray, Loungani, and Furceri argue that these goals have both hampered the economic growth neoliberalism champions and exacerbated the rise of inequality.
The pursuit of neoliberal policies, the IMF argues, by the international economic and political elite has led to what they call "three disquieting conclusions."
- The benefits in terms of increased growth seem fairly difficult to establish when looking at a broad group of countries.
- The costs in terms of increased inequality are prominent. Such costs epitomize the trade-off between the growth and equity effects of some aspects of the neoliberal agenda.
- Increased inequality in turn hurts the level and sustainability of growth. Even if growth is the sole or main purpose of the neoliberal agenda, advocates of that agenda still need to pay attention to the distributional effects.
According to Ostray, Loungani, and Furceri, an increased liberalization of a country's capital account - how easy it is for foreign investors to move money in and out of the country - appears to put countries more at risk for a financial crisis and may not aid growth as much as advertised.
"The link between financial openness and economic growth is complex," they write.
Adding:
"Some capital inflows, such as foreign direct investment-which may include a transfer of technology or human capital-do seem to boost long-term growth. But the impact of other flows-such as portfolio investment and banking and especially hot, or speculative, debt inflows-seem neither to boost growth nor allow the country to better share risks with its trading partners... Since 1980, there have been about 150 episodes of surges in capital inflows in more than 50 emerging market economies; as shown in the left panel of Chart 2, about 20 percent of the time, these episodes end in a financial crisis, and many of these crises are associated with large output declines."
So this outline basically says countries that take in certain types of speculative flows get only some of the benefits of this money coming in while assuming all of the risks.
Here's the chart:
Looking at a decreased size of the state, which Ostray, Loungani, and Furceri outline as the blunt pursuit of lowering debt-to-GDP levels via spending cuts and increased taxation (see Greece as a prime example of this in action), they find these policies appear to stress both the supply and demand sides of economy.
"It is surely the case that many countries (such as those in southern Europe) have little choice but to engage in fiscal consolidation, because markets will not allow them to continue borrowing," the IMF writes.
"But the need for consolidation in some countries does not mean all countries-at least in this case, caution about 'one size fits all' seems completely warranted."
They add (emphasis ours):
"Faced with a choice between living with the higher debt-allowing the debt ratio to decline organically through growth-or deliberately running budgetary surpluses to reduce the debt, governments with ample fiscal space will do better by living with the debt. Austerity policies not only generate substantial welfare costs due to supply-side channels, they also hurt demand-and thus worsen employment and unemployment. The notion that fiscal consolidations can be expansionary (that is, raise output and employment), in part by raising private sector confidence and investment, has been championed by, among others, Harvard economist Alberto Alesina in the academic world and by former European Central Bank President Jean-Claude Trichet in the policy arena. However, in practice, episodes of fiscal consolidation have been followed, on average, by drops rather than by expansions in output."
So unless the market is going to punish you for having a high debt burden - which would lead to increased borrowing costs via higher interest rates - there is nothing inherently bad about having debt.
The IMF notes that a national debut burden is a sunk cost that has already been assumed by the state, and argues that pursuing policies which damage both current and future economic progress exacerbates any ill-effects this debt burden might have. Which, again, may actually be overstated anyway.
And the final kicker: all this neoliberalism may have led to the income inequality we're seeing across both the developed and emerging world right now.
Ostray, Loungani, and Furceri write (emphasis mine):
"Moreover, since both openness and austerity are associated with increasing income inequality, this distributional effect sets up an adverse feedback loop. The increase in inequality engendered by financial openness and austerity might itself undercut growth, the very thing that the neoliberal agenda is intent on boosting. There is now strong evidence that inequality can significantly lower both the level and the durability of growth."
So, all things considered, this is a stunning argument against what has been the prevailing conventional wisdom among many in the international political and economic elite for a generation.
Writing in The Financial Times on Friday, Shawn Donnan notes that Ostry concedes this argument is outside the "mainstream culture" at the IMF.
This paper also reinforces the divide, at times, between the IMF's "house view" on policy and the views of its research staff with regard to how that policy may actually work.
Last summer's report from the IMF's research arm that Greece's creditors needed to take a haircut while IMF officials were working to secure Greece additional bailout funding is a prime example of this tension playing out in public.
The whole report is well worth a read, whether or not these views eventually do become something like the "house view" at the IMF or elsewhere.