Developing a coherent policy for an international agency such as the IMF thus requires identifying important instances in which markets might not work and analyzing how particular policies might address these failures. The IMF has, to date, failed to articulate a coherent theory of market failure that would justify its own existence and provide a rationale for its interventions in the market.

One of the IMF’s arguments in defense of its intervention is that an ongoing crisis in one country will spill over to its neighbors. This concept of contagion is a devastating criticism to market fundamentalism because it implies an inherent market failure. If it is desirable to take international collective action to address the consequences of a crisis, it is equally desirable to take international collective actions to reduce the likelihood that crises will occur. If an increase in the ratio of foreign short-term indebtedness to reserves (in excess of some critical threshold level) substantially increases the likelihood of a crisis, then there should be international pressure to limit short-term indebtedness; yet the IMF has pushed for capital-market liberalization, the effect of which is precisely the opposite.

Other examples of intellectual incoherence were displayed throughout the management of the Asian financial crisis. While the IMF recognized that weak financial institutions were a key factor in the crisis, it continued to use outdated macro-models that do a grossly inadequate job of incorporating the financial sector. This was remarkable, given the widespread discussion in the United States of how the failure of much more sophisticated models used by the US Federal Reserve had led to inadequate policy responses. While it should have been apparent that concern about bankruptcy was at the heart of the problem in Southeast Asia, the models used by the IMF (and worse still, the reasoning of senior IMF officials) gave no scope for bankruptcy and default and took no account of how their actions might affect either bankruptcy itself or lenders’ concerns.

There is a certain irony in this lack of intellectual coherence: the IMF is often accused of following an excessively rigid formula, a one-size-fits-all approach. I would agree with these accusations. The IMF has an ideology, a particular lens through which it looks at the world, but one should not confuse an ideological straitjacket with intellectual coherence.

The IMF Evolution

Since the creation of the IMF, there has been a subtle change in mandate, a change that, were it made explicit, perhaps would not have been widely accepted. The conflict between the effective mandate and the original mandate created a tension that manifested itself in numerous ways, including intellectual incoherence.

The IMF’s original mandate was to provide liquidity in a world of imperfect capital markets, so as to enable countries to maintain output as close as possible to full employment. Assistance was conditioned on the recipient nation’s engaging in appropriate expansionary policies. Today, the mandate often appears to be that of a bill collector for lending nations: its objective is to make sure that the debtor country has as large a war chest as possible to repay outstanding loans and to ensure the maintenance of overvalued exchange rates in order to easily acquire foreign currency. These objectives require achieving a massive trade surplus as quickly as possible, regardless of the costs to the country or its neighbors. Capital-market liberalization also reflects the interests of the financial community in advanced industrialized nations. In part, the IMF is opening up lesser-developed markets to an industry in which the advanced nations have a comparative advantage.

The IMF focuses on the repayment of loans far more than on the maintenance of the affected country’s GDP. Senior officials at the IMF repeatedly speak of defaults or standstills as an abrogation of the sanctity of contracts. They do not recognize that bankruptcy is a central institution of capitalism, that the high interest rates and high unemployment rates that their policies cause are an abrogation of the social contract under which these countries had so successfully operated for a third of a century, and that such an abrogation—and the public bailouts that follow—is the action that truly undermines capitalism and the long-term stability of society. The problem is that the IMF cannot openly announce its new mandate, and so it formulates an amalgam of policies that were both ineffective and lacking in intellectual coherence.

Other aspects of the IMF, such as its organizational structure and rules of conduct, also contribute to its policy blunders. The institution has a hierarchical structure, not uncommon among organizations that are designed to deal with crises; one cannot have intellectual debates on the best way to fight a fire in the midst of a fire. But whatever its merits in dealing with crises, such a structure often leads to organizations that do not adapt quickly. In addition, the IMF conducts much of its business behind closed doors, without transparency. The normal checks on institutional behavior, the pressures to alter its models, and the criticism of peers that is a normal part of intellectual and democratic processes simply do not exist. The IMF makes assertions and predictions concerning its policies that are consistently proven wrong, yet its leaders are seldom held accountable. With each failure, the IMF has looked to others to explain away its mistakes. Its effectiveness and credibility as an advisor are undermined by its refusal to lay out clearly the consequences of its actions and by the fact that it has lost touch with basic economics. Its success as a market psychologist is undermined by its recurring inability not only to predict but, increasingly, to affect market reactions. And its effectiveness as a political actor is weakened not only by the first two failures but also by the growing perception that its policies are dominated by the political interests of the US Treasury.

A Mandate for Reform

The simplest and most straightforward reform—one advocated by many economists on both the left and the right—is the abolition of the IMF. Some of the “public good” functions, such as data collection, could be transferred to other bodies, such as the UN Statistics Division. Monitoring could be performed by private agencies, and if considered insufficient, by existing or newly created peer-review groups like the Organization for Economic Cooperation and Development. Its development and transition programs could be assumed by the World Bank, but its core crisis-management functions would be abolished. With flexible exchange rates, the IMF simply interferes with the functioning of the exchange market, and its recent performance has reinforced the widespread view that even if markets do not work perfectly, bureaucrats are unlikely to improve matters. Without abolition, there cannot be a credible commitment not to engage in bailouts, and without such a credible commitment, lenders will have an incentive not to engage in sufficient due diligence. Excessive lending without due diligence contributes to economic instability.