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Of Terror, the IMF, Keynes, and the Fiscal Multiplier

OCTOBER 17, 2012 – Thursday October 11, International Monetary Fund (IMF) managing director Christine Lagarde said that both Greece and Spain should slow down their cuts to government spending. Well, not exactly. Her exact words were: “time is of the essence, meaning that instead of frontloading heavily, it is sometimes better, given circumstances and the fact that many countries at the same time go through that same set of policies with a view to reducing their deficit, it is sometimes better to have a bit more time” (Lagarde 2012). On its face, this makes little sense. But after wading through the doublespeak, and putting the entire quote in context, what it turns out she is saying is “slow down the cuts”. This is a complete reversal of two generations of neoliberal orthodoxy, and an implicit repudiation of the policies carried out by the IMF and its “sister” organizations in that period.

It is difficult to overstate the hypocrisy of Lagarde’s about face. The cuts against which she is now cautioning, were recommended in the first instance by … the IMF. It operates together with the European Central Bank (ECB) and the European Commission (EC), as the so-called “troika”, which arrogantly entered the waters of economic crisis in Greece, and then Spain, saying that there would be help for these troubled economies, but at a price – absolutely severe and damaging cuts to services, pensions and jobs.

The resulting “adjustment” of economies in Greece and Spain has proven more catastrophic than the IMF had anticipated. At the same press conference where Lagarde argued it was time to slow the cuts, she had earlier said: “the unemployment rates that we see in advanced economies, in particular, and among young people, are terrifying and unacceptable” (Lagarde 2012).

Indeed. In Greece, overall unemployment in the first quarter of 2012 stood at 22.5%. By July the rate had risen to 23.6%. When that rate is “seasonally adjusted”, it rises to 25.1%. For young people aged 15-24 unemployment is even worse, in the first quarter standing at a horrendous 51.2% (ELSTAT 2012a; 2012b). In Spain, overall unemployment in August stood at 25.1%, for young people, hitting 52.9% (Eurostat 2012a; 2012b). These terrible statistics can, unfortunately, be quite easily summarized: in these two countries, fully one-quarter of those who want to work are unemployed, half of all young people.

These statistics are, in fact, terrifying. But why has the IMF waited until 2012 to become terrified? It should have been terrified in Bolivia in the 1980s when IMF-sponsored “shock therapy” cuts smashed that country’s tin industry, driving thousands of miners back to the countryside to eke out a living in the coca fields (Kohl and Farthing 2006). It should have been terrified in Rwanda in the early 1990s, when IMF-sponsored structural adjustment helped to precipitate a catastrophic shredding of civil society, laying the basis for the genocide which riveted the world in 1994. It should have been terrified in Indonesia in 1998, when structural adjustment led to a massive increase in poverty (Stiglitz 2003, 89–132).

Focus on the latter country for a moment. One of the key policy recommendations of the IMF and friends in Indonesia in 1998 was to eliminate government subsidies for food and fuel – measures which devastated the lives of the poorest in the country, and led to quite understandable riots (2003, 119). This is in line with the anti-state-intervention, pro-free-market ideology which underlies all IMF-backed structural adjustment programmes. This ideology is more than just prejudice – it is a complete, carefully worked out worldview. The IMF is associated – along with two other Washington D.C. based institutions, the World Bank and the U.S. Treasury Department – with what since 1989 has been known as the “Washington Consensus” (Williamson 1990). That consensus maintains that, in the face of economic crisis, governments should cut spending and open their doors to the wonders of the free market. Being faithful to this ideology does, in fact, mean targeting policies such as fuel and food subsidies as “market-distorting” which, if left in place, will hold an economy back.

Let’s examine the question of subsidies in just a bit more detail. In Rwanda, for instance, the question of subsidies was huge – but not subsidies to the poor. The market-distorting subsidies which were blocking development in Rwanda, were billions of dollars of subsidies given every year to Global North multinationals – a class of subsidies treated somewhat differently, however, than the food and fuel subsidies in Indonesia.

Emerging from colonialism with a very poor and very rural economy, Rwanda attempted to develop by acquiring foreign exchange for investment through a shift from subsistence farming to growing crops for export. This has proven to be a difficult road for many Global South countries, and Rwanda was no exception. In the Global North, governments spend tens of billions of dollars – particularly in the European Union and the United States – to subsidize key agricultural products. Cotton production in the United States, for instance, received $24 billion in subsidies from 2001 to 2011 (Kinnock 2011). Through a “complex system of loans and quotas” sugar production (and hence sugar export) from the United States receives billions of dollars of government support (Zumbrun 2008).

These subsidies can’t be understood as support for the beleaguered, small farmer in either the U.S. or the EU. The real beneficiary is not the poor farmer in rural Pennsylvania with 16 head of Angus, but rather the huge agribusinesses. Between 1995 and 2010, in the U.S. – according to the Environmental Working Group – 74% of all subsidies ($166 billion in total) were collected by just 10% of farmers, 62% of farmers received nothing (Mercola 2012). In 2009 in the EU, “one of the biggest subsidies was $223 million, given to the French sugar conglomerate Tereos, one of whose subsidiaries produces rum on France’s Indian Ocean territory of Réunion. France’s Saint Louis Sucre also received multimillion-dollar subsidies and the British sugar giant Tate & Lyle received hundreds of thousands of dollars” (Walt 2010).

So countries like Rwanda get forced – by this system of subsidies to Global North agribusiness – into certain “niches” of agricultural commodities, such as coffee, not easily grown in the US or Europe. State support for agribusiness in the Global North squeezes them out of other potential export areas (Okonski n.d.). But coffee is notoriously vulnerable to price volatility resulting from over-production. So when in 1989 the price of coffee collapsed, so did the Rwandan economy. This was reflected in ever growing levels of external debt. In 1985, the country’s total stock of external debt was just over 200% of its export earnings. By 1990, this had grown to 480% (The World Bank 2012).

Logically, a pro free-market institution like the IMF, implementing the “Washington consensus” should have said “free the market – eliminate subsidies to Global North agribusiness.”

There are other logics at work, however. The whole systemic issue of why Rwanda had been forced into the unsustainable niche of coffee-export driven growth was never addressed. The question of eliminating subsidies given by the rich countries to Global North agribusiness was never part of the discussion – that form of state intervention is tolerated by the IMF. The IMF insisted that the problems were internal to Rwanda, and in September 1990, it “imposed a structural adjustment program on Rwanda that devalued the Rwandan franc and further impoverished the already devastated Rwandan farmers and workers. The prices of fuel and consumer necessities were increased, and the austerity program imposed by the IMF led to a collapse in the education and health systems” (Robbins 1999, 271–72). The Rwandan state was massively downsized, its capacity to support health and education completely undermined, but the states of the Global North were left untouched, free to dole out billions to multinational agribusinesses.

In addition to impoverishing Rwanda’s people, this IMF imposed structural adjustment did nothing to restart the economy. Above we looked at figures for stock of external debt as a percent of export earnings. By 1991, this was 568%; by 1992, 821%; by 1993, 864%; and in 1994, it peaked at a horrendous 1,890% (The World Bank 2012). This didn’t terrify the IMF into rethinking its austerity prescriptions. Apparently, neither did the 1994 genocide, a genocide in large part triggered by these policies.

Finally – with this round of capitalist crisis coming home to roost in Europe – the IMF has succumbed to terror. The terror is not at the human devastation caused by its policies. If that were the case, the feeling of terror would have happened years earlier in Bolivia, Rwanda or Indonesia. The feeling of terror is happening now because the IMF is seeing what its policies are doing to countries in its own heartland, on the continent of Europe. It is looking down the road at the crisis spreading from the small economy of Greece to the medium-size economy of Spain, and then to a G-7 economy like Italy – and it has finally felt the terror and started to rethink its policies.

Lagarde’s public rethinking of the austerity agenda being imposed on Greece and Spain, was triggered by a perceptive question at a press conference, where a reporter asked her about “research that appeared in the World Economic Outlook about fiscal multipliers” (Lagarde 2012). The reporter had taken the time to read the 2012 edition of the IMF’s World Economic Outlook, and get to Box 4.1 on pages 41 to 43. The contents of this box are explosive. Entitled “Are We Underestimating Short-Term Fiscal Multipliers?” it, like Lagarde’s gloss on it, requires a little translation.

The term “fiscal multiplier” is used to describe the effect of government spending on national income. “A multiplier greater than one shows that government spending on national income levels is deemed to have been enhanced” (Investopedia 2012). True to their Washington Consensus ideology, IMF staff reports, prepared to justify the structural adjustment being imposed on Greece and being proposed for Spain, based their recommendations on an assumed fiscal multiplier of 0.5 (International Monetary Fund 2012, 43). This is worth dwelling on. These IMF staff reports were assuming that $1 spent by the government would lead to just 50 cents growth in national income. In other words, government spending was a net drain on economic growth.

Now – if that were true – well then, cut everything, cut it all. If government spending of $1 leads to only 50 cents of income growth, then this is unbelievably wasteful and inefficient. If that is the case, then it would be better to spend nothing, and just give the $1 to the private sector, where that $1 will at least be a $1 increase in income, and not the measly 50 cents the IMF staff were predicting. With this as an assumption, you can see how eager IMF staff would be to slash spending in Greece, Spain and elsewhere.

Except – they know think they were wrong. After doing some more investigation, “results indicate that multipliers have actually been in the 0.9 to 1.7 range since the Great Recession … in today’s environment of substantial economic slack … multipliers may be well above 1” (International Monetary Fund 2012, 43). If that is the case – if the fiscal multiplier is above 1 – then cutting $1 in government spending will reduce national income by more than $1. In other words, cutting $1 billion in government spending will lead to a greater than $1 billion cut in national income, and will accelerate economic decline.

You can see why this is explosive. If this is in fact true, then policy should be for increasing government spending, not cutting it. The IMF document cites a series of studies – and it would benefit from studying them and not just citing them. According to one, written by Michael Woodford, when the fiscal multiplier is in excess of 1, then “welfare increases if government purchases expand to fill the output gap that arises from the inability to lower interest rates” (Woodford 2011, 1).

Lagarde is terrified (see above) because the unemployment levels in Greece and Spain are equivalent to those during the Great Depression. So read on … “Under circumstances like those of the Great Depression … government expenditure multiplier should be larger than one, and may be well above one. … Hence, a case can be made for quite an aggressive increase in government purchases under such circumstances, even taking account of the increased tax distortions required in order to finance the increase in government purchases” (Woodford 2011, 33).

This is a very old idea. In the context of another period of rather slack demand – the 1930s Great Depression – John Maynard Keynes organized his most influential work around exactly this notion – the relationship between government expenditure (public investment), national consumption, and thus aggregate employment (Keynes 2010, chap. 10). The irony couldn’t be greater. In the 21st century, sitting in the long shadow of the Great Recession of 2008 and 2009, the vehemently anti-Keynesian Washington Consensus ideologues are slowly, cautiously, stumbling back towards – Keynes.

It won’t be enough. Keynes is a whole lot better than the free market evangelism which has governed public policy in the neoliberal era. But we know from the difficulties the world economy entered into during the Keynesian era itself in the 1960s and 1970s that Mr. Keynes himself did not have all the answers.

Real policy reform will require immersing ourselves in the social movements which crises often generate. The people of Indonesia were not content to be passive objects of IMF, Washington Consensus, experimentation. In 1998 they rose up in a revolution, overthrew the dictator Suharto, and began the long march toward a society based on democracy and social justice. The tin miners who lost their jobs through IMF-imposed shock therapy in Bolivia, went to the coca fields, combined their forces with the rural coca growers (including Evo Morales), formed a powerful social movement, and became part of the revolutionary processes which stopped privatization of water in Bolivia, overthrew successive neoliberal regimes, and led to the installation of Morales as president of the now plurinational state of Bolivia.

The IMF is terrified. On the ground, the Spanish people have a better emotion – outrage. The movement of the indiganados (the outraged) in Spain, the rise of Syriza in Greece – these are some of the elements of the new social movements shaping a response to the IMF as this article is being written.

© 2012 Paul Kellogg. This work is licensed under a CC BY 4.0 license.


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