The IMF's search for a new managing director will be attracting all the attention over the coming weeks and months, but the policies it follows matter most. A catfight is now under way about which institution has been right over the past few years, the IMF with its tough treatments or the World Bank and its alternative cures.
This debate has raged underground ever since Mexico's collapse in 1995. Are IMF policies too tough, even perverse, pushing economies into bankruptcy? Are they to blame for the disastrous social fallout of the financial crises of recent years? That latter view was promoted across Asia, where governments, including that of Japan, called for an Asian IMF with alternative (softer) policies. They gained extraordinary and unexpected support from Mr Joseph Stiglitz, the World Bank's chief economist and senior vice-president, who recently advised that China should practice competitive devaluation and beggarthy neighbour policies.
For beleaguered governments, Mr Stiglitz's proposed cures were rose petals, fragrances and scented candles along with soothing sounds. Hard budget cuts and sky-high interest rates could be avoided. His pronouncements offered formidable support to those who opposed IMF rigour, indeed, and at the very least they confused the public and policymakers alike. But this was music to a Japan trying to pursue its own agenda in Asia as well as to Dr Mahatir, Malaysia's ruler, who is on an anti-establishment kick.
In the firing line, orthodoxy was defended by IMF chief surgeon, Stanley Fischer, the first deputy director and an economist with as formidable an academic reputation as Mr Stiglitz. That debate has gone on.
Who is right? Is it unreasonable to claim that the proof is in the pudding? Asia today is in the midst of a powerful recovery; crisis countries have already, or are poised to, recover their pre-crisis levels of GDP. Currencies that nose-dived in 1997/98 have strengthened substantially; markets that collapsed have turned up. Investors are flooding back. Yes there was a crisis, yes debris still lies around. But stabilisation has been nothing short of astounding. The V-shaped recovery that Mexico experienced three years ago came off bigger and faster than expected. The same pattern has held true in Brazil.
Why? IMF policies worked. Asia, Mexico and Brazil adopted and applied IMF strategies; they raised interest rates to the sky to bring about stable currencies; only with stability did they bring down rates as investor confidence returned. Asia's economies also paid attention to their budgets at a time when huge bailouts made it imperative to demonstrate fiscal conservatism.
Money started to come back, pushing exchange rates nearly up to pre-crisis levels. What at first sight seemed a meltdown, gradually came to seem just a very bad situation and soon a surprisingly rapid turnaround.
But why give IMF strategies credit? Every country followed much the same strategy. The exception was Indonesia. Every time the resolve of its government weakened, the currency collapsed; every time Indonesia returned to the IMF way, the currency strengthened.
Of course, everyone should have recognised Asia was experiencing the same cycle Mexico had recently completed. Unfortunately, the IMF failed to point out its success in Mexico and Asia's economies were allowed to think their experience was unique even if it really was a replay of what Mexico had been through.
By the time it came to Brazil, at the end of 1998 and, again, early this year, everyone knew the script: new elections, a barely averted currency collapse, embarking on the IMF programme, and a rapid rebound. So, what are the lessons? The IMF is terrible at anticipating crises; it is awful at surveillance; but it is right and successful once it comes to post-trauma treatment.
The World Bank's alternative treatments and Japan's Asian IMF are, despite lip service, not drawing too many clients. Crisis countries know better. When economies collapse in ways never expected, they reach for true religion and hard cures. They have no illusion that in the midst of a financial crisis and a speculative exodus, vast deficit spending and easy money are not the answer. Such a strategy simply defies common sense. Cheers for the IMF; cheers for its tough medicine; don't leave home without it.
Rudi Dornbusch is Ford Professor of economics at Massachusetts Institute of Technology and a former chief economic adviser to both the World Bank and IMF. Copyright: Project Syndicate
