Roland Vaubel

This selection was excerpted from "The Political Economy of the IMF: A Public Choice Analysis," published in Perpetuating Poverty: The World Bank, the IMF, and the Developing World, edited by Doug Bandow and Ian Vasquez (1994). Roland Vaubel is a professor of economics at the University of Mannheim in Germany.

This selection was excerpted from "The Political Economy of the IMF: A Public Choice Analysis," published in Perpetuating Poverty: The World Bank, the IMF, and the Developing World, edited by Doug Bandow and Ian Vasquez (1994). Roland Vaubel is a professor of economics at the University of Mannheim in Germany.

Member governments can borrow from the IMF at favorable interest rates instead of resorting to the international capital market. According to its Articles of Agreement (V.8.d and XX.2), the fund has to charge uniform interest rates to all borrowers, effectively paying the largest subsidies to the least creditworthy. The IMF also tends to give the greatest benefits to long-term debtors because, contrary to the Articles of Agreement (V.8.b), the rates are normally independent of loan duration. The uniformity of interest charges not only aggravates the moral hazard problem but also results in adverse selection of borrowers, a "lemon" problem.

Under the Bretton Woods system, the aim of maintaining stable exchange rates was used to justify cheap IMF credits. Many IMF borrowers, however, especially during the Bretton Woods era, were perfectly capable of acquiring foreign exchange via the market.

If, however, a member government is not creditworthy, the question becomes why it should be granted loans at all. There are two possible answers: to overcome imperfections of the capital market or to provide development aid. With imperfect information, the capital market would function imperfectly as well. However, if the IMF really has better information than potential private lenders about the true creditworthiness of its member governments, it could try to improve the market's information rather than to extend credit itself. Surely the fund has an obligation to make such information public for the protection of other lenders. Alternatively, subsidized IMF lending is a poor form of development aid since the IMF's criterion for extending credit (i.e., balance of payments difficulties) is not a suitable indicator of need.

Moreover, the interest rate subsidy creates an incentive to delay adjustment once a credit has been obtained=mArticle V, Section 7.b of the Articles of Agreement specifies that each member is normally expected to repay its credits (even before maturity) "as its balance of payments and reserve position improves." That runs directly counter to the objective laid down in Article I.vi that the fund should "shorten the duration . . . of disequilibrium in the international balances of payments of members."

The interest rate subsidy might be regarded as an insurance benefit against economic instability, but "premiums" do not differ according to risk. From 1960 to 1982, for example, forty-two member countries accounted for 78 percent of all standby and extended credits from the IMF. That is not an outcome to be expected if members had been hit by random accidents. In fact, cross-sectional regressions by Lawrence Officer and Peter Cornelius showed that, between 1974 and 1980, the flow of IMF credits to member governments tended to be significantly correlated with the outstanding stock of previous IMF credits. Richard Goode presented a list of twenty-four countries that have obtained fund credits for more than ten consecutive years. The maximum is twenty-seven years (Chile and Egypt). He also reported that, in 1974=n1984, drawings from non-oil-producing countries accounted for 85 percent of fund credit.

In short, the IMF is a continuous provider of aid, in the form of subsidized insurance, to a limited group of member governments. That raises four questions:

• Why do donor governments grant this form of aid?
• Why do they give the largest subsidies to the most negligent members?
• Why is the insurance offered to governments rather than to individuals?
• Why is the subsidy confined to insurance with an international public monopoly, the IMF?

The government treasury origins of the IMF are indicative. As John Makin has noted, the IMF serves the interests of the treasuries of its member governments by flexibly accommodating their borrowing and debt-servicing "needs" at minimum cost. By charging low and uniform interest rates, the IMF protects its members against market judgments and helps insure them against the electoral damage that a visibly poor credit standing might otherwise cause. The policy conditions imposed by the IMF may also be unpopular, but political leaders have occasionally made them scapegoats for unpopular economic reforms. The IMF at least provides politicians with a choice between high-risk premiums (lack of creditworthiness) in the private capital market and the IMF's policy conditions.

The IMF's professional staff also has a vested interest in subsidized, uniform interest rates. Low rates increase the demand for IMF credits. Uniform rates help avoid conflict with potential borrowers. For similar reasons, national social insurance systems and public insurance schemes for export credits and foreign investment do not usually charge premiums according to risk. Moreover, paying larger subsidies to the least creditworthy allows the fund, like national social insurance schemes, to justify its activities on humanitarian grounds. As is well known from social insurance economics, however, the poor are often not the worst risks. The debt crisis of the 1980s is a case in point: The governments of the richer developing countries, such as Mexico, proved to be the least creditworthy.