IMF: Divergent recoveries stem from divergent policies – II

New York, 21 Apr (Bhumika Muchhala) – The role of the International Monetary Fund (IMF) as lender-of-last-resort has skyrocketed during the Covid-19 pandemic, with emergency financing and loan packages disbursed to 86 countries since the outbreak of the pandemic in March 2020. However, in terms of amount, the financial firepower being made available to member countries is only a quarter of the Fund’s $1 trillion lending capacity, or $250 billion. Notably, over 50% of the IMF’s total pandemic financing is comprised of credit lines sent to just three countries: Peru, Chile, and Colombia.
In a marked departure from its past history, the IMF has supported temporary fiscal spending for health and social protection systems to allow developing countries to respond to the pandemic.
In fact, Fund leadership has repeatedly emphasized that “premature fiscal consolidation will spell the difference between a lost decade and rapid recovery that puts countries on a sustainable growth trajectory.”
Importantly, flexibility clauses to relax fiscal deficit targets appear in many financial packages. However, the story of pandemic financing does not end here. This fiscal spending is underpinned by three words that appear repeatedly in the fine print: “targeted, timely and temporary,” meaning that public spending must be reversed as the pandemic begins to subside.
According to Oxfam, fiscal consolidation measures appear in 84% of loan agreements across 67 countries beginning in 2021 and public budget cuts are to be implemented across 80 countries.
Budget cuts take the form of wage bill reductions and rationalizations, increases in regressive indirect taxation, such as value added tax, and to a lesser extent the reform of pension systems.
Social protection systems and essential social spending in health are often protected in IMF financing packages, albeit through budget re-allocations rather than through wealth and resource redistribution, such as progressive income and financial taxes. But the key trend is that in the years ahead, public budget reduction targets often trump social spending.
The IMF’s verdict is therefore fundamentally the same: eventual fiscal consolidation is “necessary” for developing countries and even least developed countries.
This is a critical challenge for the near future for two broad reasons. First, pre-pandemic social spending was severely insufficient in most developing countries.
Reversing current spending to levels below that of pre-pandemic years will stagnate long-term health, economic and social recovery for many developing countries, jeopardizing their achievement of the SDGs and Paris Agreement and risking another “lost decade.”
Many IMF loans assume that the economic crisis created by the pandemic will abate in the near term. However, it can be argued that there remains a lack of justifiable reason, especially with vaccine nationalism, to expect a near-term recovery. In fact, in May 2020, IMF staff projected that Benin would shake off the pandemic’s shock by the end of 2020. Obviously, this projection was incorrect.
Second, empirical data on impact of fiscal consolidation measures, as well as research by the IMF’s Independent Evaluation Office on the Fund’s response to the 2007-8 global financial crisis reveal that fiscal consolidation has led to reductions in health and education investments; losses of hard-earned pensions and social protections; public wage freezes and layoffs affecting public sector employees such as teachers, nurses, doctors and public civilians who comprise a large portion of the public wage bill in developing countries; increased unpaid care work; and greater consumption taxes – all of which disproportionately affect the poor and women.
New academic research in 2020 and 2021 confirms that IMF-required austerity is significantly associated with both significantly increased poverty levels as well as rising inequality, by increasing the income share to the top 10% at the expense of the bottom 80%.
Specifically, when IMF loan policies demand social spending cuts and labour market reforms and preclude longer- term fiscal support, particularly in health and social protection, the inequality already exacerbated by the pandemic stalls a real economic recovery.
Related to geo-political dynamics, empirical research of loan policies between 2001 to 2018 reveal that borrowing countries are less likely to face required austerity if they are strongly tied to Western Europe, either through trade or diplomatic channels, or if they receive significant aid from non-OECD countries (mostly China).
Borrowing countries are also more likely to face austerity if they are host to significant foreign direct investment, particularly from Western Europe.
In early 2021, the IMF’s Fiscal Affairs Department said to the Financial Times that “most advanced economies can live with much higher levels of public debt after the coronavirus crisis,” and should therefore “rethink their public finance rules rather than rushing to reduce their liabilities.”
In the April 2021 chapter of the Fiscal Monitor, the IMF states that “access to basic services helps give everyone a fair shot but is costly.”
To meet these costs, progressive wealth taxation is proposed as a principal means of mustering the necessary revenues. The Fund even suggests that alongside reducing income inequality, wealth taxes can also increase inter-generational mobility. However, this advice to increase income, inheritance/gift and property taxation is directed very specifically to “advanced economies.”
For many developing countries, the Fund calls for increased revenue collection through value-added tax, an indirect consumption tax applied to many daily use products and services which impact the poor, especially women and children, disproportionately.
However, in its loans to developing countries, the Fund calls for mobilizing domestic revenue, in the medium term, through raising regressive taxes or removing exemptions to such taxes in several countries.
The Fiscal Monitor stresses the salience of “strengthening social safety nets by expanding coverage of the most vulnerable households and investing more and better in education, health, and early childhood development.”
In the same breath, the directive to developing countries remains rigid in stance: “Once the recovery is underway, gradual fiscal consolidation will become necessary in many cases, but this must be undertaken in ways that not only protects essential social spending, including health and education spending, but also allows appropriate levels of public investment.”
Meanwhile, in 7 out of 16 countries that have acquired new IMF loan programs since October 2020, the Fund is calling for cutting or freezing the public sector wage bill, which pays the salaries of public sector doctors, nurses, teachers and teaching aides in many developing countries.
Costa Rica has already eliminated over 2,000 public sector positions, and has frozen public sector wages (with exceptions for healthcare workers and the police) as well as placed a pause on almost 5,000 public vacancies.
The antidote to fiscal consolidation measures has historical precedents. In the postcolonial period, newly independent countries ran fiscal deficits financed by printing money to develop their nascent economies. Unlike European countries who received the Marshall Plan from the US in the post-World War II period, developing countries were not supplied with any funds, domestic or foreign. Governments employed fiscal activism to build infrastructure and create public systems and systems in health and education. With the backlash against Keynesian fiscal policy in the late 1970s and early 1980s and the turn toward the liberalizing tenets of neoliberalism, public budgets fell subject to fiscal disciplining through stringent fiscal deficit and inflation targets.
The 2008 global financial crisis generated a brief revival of fiscal spending for social needs, with large stimulus and bail-out packages in developed countries and public infrastructure investment and, to some degree, social protection measures in developing countries. However, in the years since the global financial crisis, fiscal contraction through spending cuts in public and social services, again became the norm. Regressive taxation, mainly on consumption, has grown while direct taxation on corporate and personal income and assets have decreased.
It is clear that fiscal consolidation, even if in the medium to long term, will derail pandemic recovery for many developing countries, while also harming human rights and the achievement of SDGs and the Paris climate agreement. This requires contesting and rewriting the fiscal rulebook in order to create, expand and maintain fiscal space for social and human development. Some elements of such a task include re-conceptualizing the investment character of public expenditures, the formulation of rights- and development-based criteria for public financing and acceptance of these criteria by international and national lending institutions.
A progressive fiscal framework recognizes that human development is the ultimate return that public investment strategies must be rooted in. The SDGs have the potential to provide the basis for developing such a fiscal framework, and would require fundamental changes to fiscal rules currently focused on fiduciary solvency and flawed debt sustainability assessments. Fiscal progressivism entails allowing for higher budget deficit paths and/or higher levels of inflation without jeopardizing macroeconomic stability. The higher deficits should ensure relief for the vulnerable, especially women and children as well as informal sector and casual employment workers, prevent recessions from becoming depressions, and mobilize progress toward structural transformation.
On the occasion of the IMF’s Comprehensive Surveillance Review due to be completed in May, during which the IMF reassesses how it identifies risk and provides policy advice in its surveillance work, a broad-based group of civil society organisations developed a proposed framework for how the IMF could better approach gender and economic inequalities and climate change issues in its country-level work. The framework offers the Fund a way to start addressing these issues more systematically and confront its own role in exacerbating these crises of our time.
Long-term recovery is not limited to resolving the interlocked crises exacerbated by the pandemic, it is concerned with the foundations of systemic and intersectional inequality in the global economic architecture. As such, recovery is about diversifying and strengthening the real economies in developing countries away from commodity, extractive sector and global value chain dependency and toward an ecologically sustainable nexus of productive investment, decent work creation and secure financing for public systems and services. Rethinking fiscal rules is an elemental step toward such a transformative recovery.
Published in SUNS #9331 dated 22 April 2021