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Economic Governance and Crisis Management

Economic Governance and Crisis Management. Jean-Frédéric Morin Université libre de Bruxelles. The Twin Financial Crises. Currency crises Deficit in the balance of payments Run of official foreign exchange reserves Downward pressure on exchange rate. Banking crises

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Economic Governance and Crisis Management

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  1. Economic Governance and Crisis Management Jean-Frédéric Morin Université libre de Bruxelles

  2. The Twin Financial Crises Currency crises Deficit in the balance of payments Run of official foreign exchange reserves Downward pressure on exchange rate • Banking crises • Massive deposits withdraw • Bank runs • Credit crunch

  3. Frequent Assumptions 1) Wise decision-makers could avoid crisis; 2) The IMF coerces developing countries; 3) The US controls IMF decision making; 4) IMF policies weaken borrowing States; 5) Crises strengthen multilateral economic governance. 1. Can States avoid crises? 4. What impact IMF has on borrowers? 5. Do crises strengthen IMF? 2. Does the IMF coerce borrowers? 3. Does the US control the IMF?

  4. 1. Can States avoid crises? .

  5. The State or the Market? “Recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, properly phased and growth-friendly plans to deliver fiscal sustainability […]. Those countries with serious fiscal challenges need to accelerate the pace of consolidation. […] We agreed the financial sector should make a fair and substantial contribution towards paying for any burdens associated with government interventions, where they occur, to repair the financial system or fund resolution, and reduce risks from the financial system. We recognized that there are a range of policy approaches to this end. Some countries are pursuing a financial levy.” - The G20 Toronto Declaration, June 2010

  6. The First Generation • Ex: Paul Krugman (1979) • Imbalances in macroeconomic fundamentals • Fiscal policy • Monetary policy

  7. Public Debt Source: UNCTAD, Responding to the Challenges Posed by the Global Economic Crisis to Debt and Development Finance, New York, United Nations, 2010, p. 36

  8. The Unholy Trinity Free capital flow Canada France Fixed exchange rate Sovereign monetarypolicy China

  9. The Second Generation • Ex: Maurice Obstfeld (1986) • Speculative attacks are not justified by underlying economic fundamentals. • Self-fulfilling prophecy from speculators • Regional contagion effect

  10. The 1997 Asian Crisis King, Michael R. “Who Triggered the Asian Financial Crisis?”, Review of International Political Economy, vol. 8(3), 2001, p. 450

  11. How to Strike Back?

  12. The Third Generation • Neither the State nor the market, but their relation. • Institutions are required for cooperation • Iteration is required to build trust

  13. Levels of Trust Aykens, Peter, “(Mis)trusting Authorities: A Social Theory of Currency Crises”, Review of International Political Economy, vol. 12(2), 2005, p. 321.

  14. Trust: An Intervening Variable • New democracies, unanticipated cabinet dissolutions, government turnovers, and divided governments increase probability of currency crisis • Autocracies are more likely to experience currency crisis than democracies. Leblang, David & William Bernhard “The Politics of Speculative Attacks in Industrial Democracies”, International Organization, vol. 54(2), 2000, p. 291-324. Leblang, David & ShankerSatyanath, “Institutions, Expectations, and Currency Crises”, International Organization, vol. (60), 2006, p. 245-262.

  15. Trust-Building Institutions • Central bank independence • Pegged exchange rates • Insulate monetary policy • Significant loss of flexibility

  16. Central Bank Independence Bernhard, William, Lawrence Broz and William Roberts Clark, “The Political Economy of Monetary Institutions”, International Organization, 56(4), 2002, p. 698

  17. Fixed Exchange Rates Bernhard, William, Lawrence Broz and William Roberts Clark, “The Political Economy of Monetary Institutions”, International Organization, 56(4), 2002, p. 701

  18. Trust and Transparency Central bank independence and fixed exchange rates are not policy substitute • Central banks are opaque and difficult to monitor • Exchange rate pegs are easily observed The selected institution’s transparency is inversely related to the political system’s transparency • Autocracies are more likely to have fixed exchange rates • Democracies are more likely to have independent central banks Broz, J. Lawrence, “Political System Transparency and Monetary Commitment Regimes”, International Organization, vol. 56(4), 2002, p. 861-886

  19. 2. Does the IMF coerce developing countries with conditionality? .

  20. Does the IMF coerce? No! • No significant correlation • Post Washington consensus • IMF is flexible • Borrowers have interests in conditionality Yes! • Asymmetry of power • Increasing use of conditionality • Capacity to monitor and to sanction

  21. Does the IMF bargain? Yes! • Conditions vary greatly • Borrowers have alternatives • Domestic politics can increase bargaining power No! • Not time for bargaining • False alternatives

  22. Does the IMF socialize? Yes! • Several socialization opportunities • The “ownership” paradigm • Developing countries are receptive to IMF arguments No! • Surveillance and peer-review are not designed for socialization

  23. 3. Does the US control the IMF decision making?

  24. An Autonomous Bureaucracy? A homogeneous bureaucracy of liberal economists... …relatively independent from the executive Board… …With their own preferences

  25. A K-Group Hegemony ? • We should not forget the Europeans • A G5 coalition can have major impact • But a split in the G7 favors IMF autonomy

  26. The “G1” as the Principal Anecdotal evidences • Turkey 1998 (Önis, 2006) • Egypt 1987 and 1991 (Momami 2004) Statistical evidences (Stone 2008; Thacker 1999; Dreher & Jensen 2007; Oatley & Yackee 2004; Broz & Hawes 2006; Barro & Lee 2002) • US allies more likely to have loans • US allies receive fewer conditions • US allies are punished less severely for non compliance • Strategic countries receive larger loans

  27. Congress is key • Congress has constitutional power and uses it • Constituencies and interest groups influence Congress votes Broz, Lawrence and Michael Brewster Hawes, “Congressional Politics of Financing the International Monetary Fund”, International Organization, vol. 60 (2006), p. 367-399 Broz, Lawrence “Congressional Politics of International Financial Rescues”, American Journal of Political Science, vol. 49(3), 2005, p. 479-496

  28. 4. Does conditionality politically weaken developing countries ?

  29. According to the IMF… “The results show that the presence of an IMF-supported program does not reduce public spending on either health or education—measured as a share of total public spending, GDP, or in per capita real terms. In fact, we estimate that during program periods, and with all other factors being the same, public spending in each of the health and education sectors increased by about 0.3 to 0.4 percentage points of GDP compared to a situation without a program” - IMF Independent Evaluation Office, 2003, p. 8

  30. The cost of Crises Keefer, P. “Elections, Special Interests, and Financial Crisis”, International Organization, vol. 61, 2007

  31. Regime Type Matters • The effect on social spending is particularly pronounced in democracies (Nooruddin & Simmons 2006) • Autocracies react to crisis with higher decisiveness (Haggard and MacIntyre 1998)

  32. So Autocracies Are Better Off? • Credibility is as important as decisiveness (Keefer, 2007) • A wide dispersal of veto authority increases rigidity but a centralization of veto authority increases volatility. • A balanced distribution of authority is optimal (MacIntyre 2001)

  33. Philippines: A Balanced System Source: MacInyre, Andrew, “Institutions and Investors: The Politics of Economic Crisis in Southeast Asia” International Organization vol. 55(1), 2001, p. 83

  34. 5. Do Crises Strengthen multilateral economic organizations?

  35. Crisis and Multilateralism • IMF faces harsh criticisms during crises • The lack of crises is even more challenging • Some multilateral institutions benefit more from crisis than others

  36. Crisis and Regionalism • The European model • The Asian model

  37. Crisis and Unilateralism

  38. Frequent Assumptions 1) Wise decision-makers could avoid crisis; 2) The IMF coerce developing countries with conditionality; 3) The US controls the IMF decision making process; 4) IMF policies politically weaken borrowing States; 5) Crises strengthen multilateral economic governance. 1. Can States avoid crises? 4. What impact IMF has on borrowers? 5. Do crises strengthen IMF? 2. Does the IMF coerce borrowers? 3. Does the US control the IMF?

  39. Conclusion • Actors are not rational and do not operate with perfect and complete information • Institutions are crucial to manage expectations • Loans negotiation is a two-level game, both for the borrower and the lender

  40. Economic Governance and Crisis Management Jean-Frédéric Morin Université libre de Bruxelles

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