IMF retrofit: Fund learns as it lends

The IMF is slowly coming to terms with the need for social welfare to counter its negatives. But some attach little weight to implementing social spending

The hollowing out of the middle class, rising social and political tension, lack of education, globalisation and rapid technological changes are just a few of the many drivers of growing income inequality. An IMF blog page article, “Tackling Income Inequality Requires New Policies’ in May 2019 begins with these words. ‘Has the time come to welcome a more pluralist fiscal policy?’” Don’t we need to shed this notion that an expanding Government in itself is bad?
Yes, we need a different perspective at the IMF (and by international organisations more broadly) which acknowledges that there are different ways to achieve debt sustainability and reduce income inequality. While the Fund’s change in rhetoric is laudable, I am skeptical that it will change its ways fundamentally for two reasons. First, despite criticism in the past, it has been reluctant to significantly alter its policy advice. Second, even though it talks about socioeconomic issues of the day, it continues to frame them predominantly in market-oriented terms.

A discussion involving IMF’s Gita Gopinath, World Bank’s Pinelopi Koujianou Goldberg and OECD’s Laurence Boone quoted in the same May Blog has given some hints of emerging perspectives. Ms Gopinath has stressed on awareness about distinctions in income inequality within countries. “If you look at advanced economies there’s certainly a trend towards an increase in inequality between 1990 and now,” she said. “But then when you look at emerging and developing economies, it’s more mixed.” The issue highlighted by her shows the complexity involved in developing a policy prescription that encompasses such distinctions.
Indeed, driving forces behind rising inequality differ because the structural conditions in advanced economies and elsewhere vary. At the same time, one can also identify common themes. For example, globalisation may well have contributed to increasing inequality in both developed and emerging economies. In the former group of countries, outsourcing led to wage stagnation amongst low-skilled labour. In the developing world, demand for relatively skilled labour increased, and individuals at the upper end of the income distribution benefited the most. Furthermore, policies such as labour market flexibilisation increase the bargaining power of employers in any context — at the expense of labour. Thus, it is wrong to excuse oneself from the fight against inequality based on the logic that it is too complex an issue.

Tax evasion by large corporate firms has been identified as a major reason for growing inequality. Wealth funnelled off through tax evasion creates tax havens. OECD’s Laurence Boone is clear on the issue. She says “At the global level, we must ensure that firms pay their fair share of taxes to create value and employ people.” What is the way for an equitable tax system that could lead the way for a level playing field?
This is an interesting question which is heavily debated in social sciences. While I am no expert on this issue, progressive personal and corporate income taxes seem an indispensable starting point. However, it is important to also focus on international-level determinants of tax policy, particularly in the developing world. For example, ongoing research by my colleagues shows that the IMF has typically placed a premium on broad-based consumption taxes while discouraging trade taxes. In particular, IMF programmes increase revenues derived from goods and services taxes, but decrease revenues collected from trade taxes.

IMF and World Bank are often accused of advocating ‘one size fits all’ policy across countries. Are multilateral institutions like IMF telling us obvious facts a little too late? Can the principle, “better late than never”, be applied here? Common phrases like labour market flexibility resulted in unsecure employment and lack of decent livelihood?
It is important to first acknowledge that the notion of ‘one size fits all’ policy recommendations hold only to a certain extent. It is true that the IMF and the World Bank have been promoting market-oriented reforms for decades. However, individual elements of their policy advice vary. Thus, it is important to disentangle the constituent parts of lending programmes. In our research, we find that public expenditure reductions, trade and capital account liberalisation, financial sector conditions, and external debt policy reforms all contribute to growing inequality, although to different degrees. Furthermore, the IMF and World Bank remain key actors in global governance. For as long as they continue to significantly affect economic policy in the developing world, it is ‘better late than never’ for the institutions to change course, and to acknowledge and correct for their mistakes of the past.

Social welfare to counter this involves a larger role for the State. Do institutions like IMF recognise this? Last but not least, at what cost should a nation achieve fiscal and current account balance (This is not an argument for any sort of profligacy)
It seems that the IMF is slowly, very slowly, coming to terms with this. For a number of years now, some lending programmes have included explicit poverty reduction measures and social spending floors. Having said that, research by my colleagues shows that IMF staff continue to prioritise other quantitative targets and attach relatively little weight to the implementation of these social spending floors. Thus, the IMF still has a long way to go. As to the question regarding fiscal and current account balance, it is important to strike a balance between demands of external actors, e.g., international financial markets or donors, and domestic politics. While excessive trade account deficits and debt unsustainability impede economic growth, the other end of the spectrum is similarly troublesome. At the other extreme are countries like Germany; it which sells abroad more than it imports, leading to a positive current account balance.

However, research by the IMF has linked the growing current account surplus to increasing inequality in Germany, suggesting that corporations distribute the increased gains from cross-border activity unevenly among their employees. Fiscal and current account balance are therefore important, but should not be the ultimate goal. Instead, it should be treated as a means to achieve prosperity in the developing world.

(The author is a PhD candidate in International Relations, Berlin Graduate School for Global and Transregional Studies, Free University Berlin)