IMF Programs: Who Is Chosen and What Are the Effects?
Robert J. Barro, Harvard University
Jong-Wha Lee, Korea University
IMF loans react to economic conditions but are also sensitive to political-economy variables. Loans tend to be larger and more frequent when a country has a bigger quota and more professional staff at the IMF and when a country is more connected politically and economically to the United States and major European countries. These results are of considerable interest for their own sake. More importantly for present purposes, the results provide instrumental variables for estimating the effects of IMF loan programs on economic growth and other variables. This instrumental estimation allows us to sort out the economic effects of the loan programs from the responses of IMF lending to economic conditions. The estimates show that a higher IMF loan-participation rate reduces economic growth. IMF lending does not have significant effects on investment, inflation, government consumption, and international openness. However, IMF loan participation has small negative effects on democracy and the rule of law. The reduction in the rule of law implies an additional, indirect channel whereby IMF lending reduces economic growth.
*This research has been supported in part by a grant from the National Science Foundation. We appreciate comments from Alberto Alesina, Eduardo Borensztein, Jeffrey Frankel, Jeffrey Frieden, Jinyong Hahn, Mohsin Kahn, Myoung-jae Lee, Greg Mankiw, and seminar participants at the Australian National University, Harvard University, the International Monetary Fund, the Korean Econometric Society Workshop, the State University of New York at Buffalo, and Tokyo University. Yunjong Eo provided valuable research assistance.
In recent decades, many countries have participated in loan programs of the International Monetary Fund. In fact, almost all developing countries have received IMF financial support at least once since 1970. The few exceptions include Botswana, Iraq, Malaysia, and Kuwait.
Given the broad reach of IMF loan programs, it is important to know the consequences of these programs for economic growth and other dimensions of economic performance. Do countries benefit from access to IMF loan programs or would countries be better off if these programs did not exist?
The main difficulty in answering this question is that IMF loans tend to be made in response to economic problems. This response, akin to a doctor administering to a sick patient, tends to generate a negative association between IMF loan programs and economic performance. Obviously, it would be unfair to blame the IMF for these pre-existing bad conditions. Thus, to assess the economic effects of the loan programs, one has to sort out the directions of causation, that is, distinguish the economic effects of the loans from the effects of economic conditions on the probability and size of the programs. Similar issues arise in evaluating foreign aid, debt relief, and other programs that respond to the economic health of a country.
To sort out the directions of causation, we would ideally observe experimental situations in which the IMF introduced a loan program without regard to a country’s economic conditions. We try to approximate these sorts of experiments by taking a political/institutional approach to the IMF’s decision-making. That is, we construct and use some political and institutional variables that, first, have substantial predictive value for IMF loan participation and, second, are exogenous with respect to economic performance. We then use these political and institutional variables to form instruments to isolate the effects of IMF loan programs on economic growth and other variables.
The key innovation of our analysis is that we model the IMF as a bureaucratic and political organization. Loans are more likely to be approved and are likely to be larger when countries are more influential at the IMF. We gauge this influence by the size of a country’s quota at the IMF and by the number of the IMF’s professional staff that come from the country. We also consider each country’s political and economic connections to the most influential members of the IMF, the United States and the major countries of Western Europe. To measure these connections, we use voting patterns in the United Nations and the extent of bilateral trade linkages.
Our analysis shows that IMF loans are more likely to exist and to be larger in size when countries have larger quotas, more nationals on the IMF staff, and are more connected politically and economically to the United States and the major Western European countries. Considered as a whole, these political-economy variables have substantial explanatory power for IMF lending.
Our political-economy analysis of the determinants of IMF loan programs is of considerable interest for its own sake. However, most importantly, this analysis generates the instrumental variables that we use to study the effects of these programs. We can reasonably argue that our instrumental estimates isolate the effects of the loan programs on economic growth and other variables.
Overall, our results are not favorable for the economic role of the IMF. We find that, using our instrumental variables and holding fixed an array of other explanatory variables, greater IMF loan participation has a direct negative effect on economic growth. We also find that more participation and larger loans have small negative effects on democracy and the rule of law. The reduction in the rule of law provides another, indirect channel whereby IMF loan programs lead to lower economic growth.
I. Characteristics of the IMF
The IMF has become an almost universal financial institution, with its membership rising from 44 states in 1946 to 184 at present. However, the members of the IMF do not have an equal voice. Each member contributes a quota subscription, as a sort of credit-union deposit to the IMF. Upon joining the Fund, a country pays 25 percent of its quota in the form of international currencies or SDRs and the remaining 75 percent in its own currency. The quota is the basis for determining voting power: each member has 250 basic votes plus one additional vote for each SDR 100,000 of quota. The initial quotas of the original members were determined at the Bretton Woods Conference in 1944. The allocations were based mainly on economic size, as measured by national income and external trade volume. Quotas of new members have been determined by similar principles.
The IMF charter calls for general quota reviews at intervals of no more than five years. These reviews allow for adjustments of quotas to reflect changes in economic power. There have been 12 general reviews since 1950, and 6 of these resulted in an increase in the total size of quotas. Most of these overall increases featured equi-proportional increases of quotas for the individual members (IMF ).
The IMF’s Board of Governors delegates most decision-making power to the Executive Board, which has 24 directors. Eight directors are appointed by the largest eight shareholders—the United States (37,149 million SDRs or 17.5% percent of the total IMF quotas), Japan (6.3% percent), Germany (6.1%), France (5.1%), the United Kingdom (5.1%), Saudi Arabia (3.3%), China (3.0%), and Russia (2.8%). The others are elected by sixteen groupings of the remaining countries.
The major shareholders have strong influences on the IMF’s decisions. Many important decisions require special voting majorities of 85 percent. Hence, the United States alone and a group of three major Western European countries have veto power. Although the managing director has traditionally been a European, the United States has exerted the strongest voice at the IMF and has sometimes openly wielded this power to influence decisions (Kahler  and Stone ).
On December 31, 2002, the IMF had a staff of 2681—763 assistant staff and 1918 professionals. About two-thirds of the professional staff were economists (IMF [2003, p.87]).
The basic conception of the IMF’s role, as envisioned at Bretton Woods in 1944, was to promote exchange stability and provide short-term finance to deal with temporary current-account deficits in advanced countries. Thus, with the breakdown of the “par adjustable peg system” in 1973, the IMF lost its major role as the “guarantor of fixed exchange rates” among advanced countries. Nevertheless, the IMF did not disappear, and its role expanded instead into many new areas. The IMF has now evolved into the “crisis manager” and “development financier” for developing countries.1
The primary role of the IMF is to provide credits to member countries in balance-of-payments difficulties. Part of the credit is provided in relation to a country’s quota. The first tranche, 25% of the quota, is available automatically, without entailing any discussion of policy. The use of IMF resources beyond the first tranche almost always requires an arrangement between the IMF and the member country. Under an IMF arrangement, the amount of resources committed is released in quarterly installments, subject to the observance of policy benchmarks and performance criteria. This process is often called conditionality.
Stand-by Arrangements (SBA) and the Extended Fund Facility (EFF) are the main IMF programs designed to provide short-term balance-of-payments assistance to member countries.2 The typical Stand-By Arrangement covers a period of 1 to 2 years, with repayments scheduled between 3 1/4 and 5 years from the date of the borrowing. The Extended Fund Facility program, introduced in 1974, was intended to provide somewhat longer-term financing in larger amounts. The EFF arrangement typically lasts up to 3 years, with repayments scheduled over a period of 4 1/2 to 10 years.
The SBA and EFF programs did not cover very low-income countries. Confronted by increasing pressure, the IMF developed several new lending programs to provide long-term loans at subsidized interest rates for poor countries. The Fund established the Structural Adjustment Facility (SAF) in 1986 and the Enhanced Structural Adjustment Facility (ESAF) in 1987. The interest rate charged is 0.5%, and repayments are scheduled over 5-10 years after a 5-year grace period. Most ESAF cases were with sub-Saharan African countries and former planned economies. In 1999, the ESAF was replaced by the Poverty Reduction and Growth Facility (PRGF). Probably these activities should be viewed more as foreign aid, rather than lending or adjustment programs.
Table 1 shows the number and amounts approved for all types of IMF programs from 1970 to 2000.3 Over this period, a total of 725 programs were approved. This total includes 594 short-term and mid-term stabilization programs (SBA and EFF), which are the focus of our analysis. The number of these short-term programs peaked in the early 1980s with the Latin American debt crisis. Although the number declined subsequently, the average size of the loans rose because of the financial crises experienced by larger countries, such as Mexico, South Korea, Russia, Brazil, Argentina, and Turkey.
II. Determination of IMF Loan Programs
Participation in an IMF program is a joint decision between a member country and the IMF. Countries that are experiencing economic difficulties come to the IMF for a financial arrangement. Then the IMF determines whether the country meets the Fund’s criteria for approval. In this section, we estimate the economic and institutional variables that influence the size and frequency of IMF lending.
A. IMF Loan Programs
To capture the economic determinants of IMF lending, we use a number of standard variables that can be found in the previous literature, which is surveyed by Knight and Santaella (1997) and Bird and Rowlands (2001). Some of these factors can be viewed as influences on a country’s demand for loans and others as effects on the IMF’s willingness to supply loans.4 The explanatory variables included for each country and time period are the level of international reserves in relation to imports, per capita GDP, total GDP, the lagged growth rate of per capita GDP, and a dummy variable for OECD membership.5
We extend the previous literature by including a number of institutional and political-economy variables as determinants of IMF lending. The first institutional variable is the country’s share of IMF quotas. The quota measures a country’s voting power at the IMF and also matters directly for a portion of the lending available to a member. Our hypothesis is that, for given economic conditions, a higher country quota raises the probability and size of an IMF loan.
In practice, quotas are persistent over time, with much of the allocations determined by the rules set out in 1944 at Bretton Woods. Basically, economically larger countries get larger quotas, but the concept of economically large involves the long ago past, rather than the present. For our purposes, we are most interested in countries that have unusually high or low current quotas, relative to their economic sizes. To get a sense of the outliers, we ran an OLS regression of IMF quota shares in 2000 on the levels of total and per capita GDP in 1995.6 The residuals from this regression show that the countries that were most over-weighted on quotas were the United Kingdom, France, Russia, and Venezuela. The most under-weighted were China, South Korea, Hong Kong, and Taiwan. (Hong Kong and Taiwan, as non-members, have zero quotas.)
The second institutional variable is the share of a country’s nationals among the IMF professional staff of economists. Officially, to avoid conflicts of interest, the IMF does not allow staff members to have direct influence on lending decisions for their home countries.7 However, from the standpoint of having good information, the IMF often seeks input from the nationals of a target country. Therefore, although own nationals cannot work directly as desk economists or mission team members for their home countries, these nationals are often sought out for comments on country programs. In addition, the presence of own nationals on the staff can help a country to get more access to inside information and, thereby, make it easier to negotiate with the IMF on the terms of a program. Our hypothesis is that, for given economic conditions, a larger national staff at the IMF raises the probability and size of a loan.8
We measured the staff for each country by the number of home-country nationals currently working for the Fund. Unfortunately, we lack the information to refine the staff data to consider ranks of positions. Also, it would be interesting to consider the number of ex IMF staff economists who currently work in the governments of their home countries. However, we lack the information to make this extension.
As with quotas, the number of nationals working at the IMF tends to reflect the economic sizes of countries (although the fit for staffs turns out to be substantially poorer than that for quotas). For our purposes, we are most interested in countries that have surprisingly high or low staffs. To get a sense of these outliers, we ran another OLS regression, this time for IMF staff shares in 2000 on levels of total and per capita GDP in 1995. The residuals from this regression show that the countries that were most over-weighted on the IMF staff were the United Kingdom, France, India, Canada, and Peru. Those that were most under-weighted were China, Japan, Indonesia, Taiwan, and Hong Kong.
One concern is that the number of country nationals on the IMF staff is endogenously determined by the country’s experience with IMF programs, rather than the reverse. However, a country’s history of IMF program turns out not to have much impact on the hiring of that country’s nationals—the lagged loan-participation rate lacks significant explanatory power for the size of the national staff.9
The IMF is also a political organization governed by its major shareholders. A common claim is that the IMF plays the roles best suited to the national interests of the United States. In the Cold War era, the IMF often supported countries—such as Argentina, Egypt, the Philippines, and Zaire—that were important to the United States for foreign policy reasons, despite the lack of effective reform programs (see Krueger  and Bordo and James ). This sort of political influence was clear in the 1994 Mexican crisis, where the IMF approved a loan of unprecedented scale, $17.8 billion. The loan approval process featured intense lobbying by the U.S. government, including an incident where the Clinton Administration’s pressure for rapid action was so strong that the usual minimal notice to executive directors was not given. In protest, some European directors abstained in the voting (Krueger ). As another example of U.S. influence, in December 1997, the IMF approved a record-breaking loan to South Korea, $21 billion. In this case, the U.S. Treasury and the IMF apparently collaborated to work out the form of the package (Blustein ).
We use as a proxy for a country’s political proximity to the United States the fraction of the votes that each country cast in the U.N. General Assembly along with the United States.10 We construct analogous variables for France, Germany, and the United Kingdom. Our hypothesis is that greater political proximity to the United States and the major Western European countries raises the probability and size of IMF loan programs.
A study by Thacker (1999) used a different form of U.N. voting variable to investigate the U.S. influence over the IMF’s lending decisions.11 U.N. voting variables have also been used by Ball and Johnson (1996) and Alesina and Dollar (2000) to explain foreign-aid patterns.
We measure economic proximity to the United States by the ratio of the country’s bilateral trade with the United States to the country’s GDP. We construct analogous variables for the three Western European countries. Our hypothesis is that greater trade intensity with the United States and the European countries raises the probability and size of IMF loan programs.12