The bail-out money is still flowing – Greece is just the latest to get a multi-billion loan. But do these kind of rescue packages ever do what they’re supposed to do? Simon Wilson reports.
What has Greece agreed?
On the promise of a bail-out worth €80bn from the EU and e30bn from the IMF, Greece has agreed to slash its budget deficit from 13.6% of GDP last year to 8.1% this year, and 2.6% by 2014. By then it’s expected to be self-financing again. Obviously there is no guarantee the measures will work. Argentina, Indonesia, Uruguay and the Dominican Republic are all examples of countries where in recent years their governments adopted IMF measures but defaulted anyway. On the other hand, South Korea, Turkey and Mexico have all avoided default due to large-scale external assistance.
Any European examples?
Three European nations received emergency IMF money at the height of the financial crisis – Latvia, Romania and Hungary. And as Michael Winfrey of Reuters argued recently, their examples offer grounds for both optimism and alarm. On the face of it, the targets set by deficit reduction quickly proved to be unrealistic. Latvia agreed a e7.5bn injection in December 2008, but posted a deficit of 9.0% of GDP for 2009 instead of the 4.9% agreed. Romania took a €19.9bn bail-out in May 2009, and produced a deficit of 7.2%, compared to a 4.6% target. Hungary took €20bn, and did slightly better.
However, the bail-outs took place against a backdrop of the worst global downturn since the 1930s and all three states suffered collapsing GDP (down 18% in Latvia, 6.3% in Hungary) due to a slump in external demand. The prospects for Greece are arguably more promising. First, the European economy as a whole is now slowly recovering. Second, Greece may have more room for radical reforms to the public sector than the others: clamping down on endemic tax evasion; scrapping redundant state bodies and endings its arcane and lucrative system of public-sector bonuses, for example.
So Greece should be just fine?
Not necessarily. There are other differences between these recent bail-outs and Greece’s. In each earlier case, the government concerned was eager to accept IMF help, and faced little public opposition to austerity measures. Not so Greece, where protests threaten to cripple the economy over the summer. Note too that while Romania, Latvia and Hungary have all won back enough respect from financial markets to resume issuing bonds, in all three cases falling GDP frustrated austerity measures by pushing up unemployment and welfare spending and reducing the tax take. Critics refer to this as the IMF trap.
What is the IMF trap?
The IMF bail-out is based on the assumption that Greece’s economy will contract 4.0% this year and 2.6% next. But if Athens does manage to push through all its planned austerity measures, there’s a big risk growth will be far weaker. This is a familiar trap for previous recipients of IMF funding. In Argentina’s crisis of 2000/2001, a combination of austerity, falling GDP and lower budget revenues created a self-reinforcing cycle that pushed up deficits. So it is possible that the new wave of austerity risks pushing the entire EU into a period of low growth just as it starts to re-emerge from recession.
So IMF intervention is a bad thing?
Not always. It can help restore confidence by providing cover for unpopular policies in the face of domestic opposition. Britain’s experience in 1976/1977 is an example. As confidence returned in the wake of IMF support, sterling rose so fast that the Bank of England was forced to intervene. In the end, a big slice of the IMF facility went unused, leading to accusations that the unpopular spending cuts had been too harsh. But as Larry Elliott argues in The Observer, Britain got off lightly compared to some of the countries the IMF has ‘helped’. The shock therapy it applied to Russia at the end of the 1980s led to a collapse in industrial output. As Joseph Stiglitz noted: “The IMF kept promising that recovery was round the corner. By 1997, it had reason for this optimism. With output already down 41% since 1990, how much further was there to go?”
What about the Asian crisis?
Like Russia, the countries worst affected by the 1997-1998 crisis (Thailand, South Korea, Indonesia) were treated to the IMF medicine of spending cuts, higher taxes and lower subsidies. According to former OECD economist John Llewellyn, it was “the wrong medicine. If the problem is a lack of private demand, the right approach is for governments to spend… The IMF told them to do the opposite.” Politically, it was a disaster and made Asia distrust the West – when the crisis hit the West ten years later, the West did precisely the opposite. Greece is still wary of the men from Washington – perhaps it is right to be.
What about Argentina’s example?
Recent history suggests that the protestors in Athens are right to be wary of the strings attached to the IMF’s assistance, argues Larry Elliott. During the 1990s, Argentina was a ‘poster boy’ for the Washington consensus, enduring a decade of austerity culminating in full-blown crisis. In 2001, it decided that “default and devaluation was preferable to indefinite economic agony” and abandoned its IMF programme entirely. But whereas the IMF warned that the result would be “pariah status, deep recession and hyper-inflation”, the reality was that Argentina’s economy grew by more than 60% over the subsequent six years.