Cyclopedia Of Economics 3rd edition

A typical week at the IMF in June 2002.

Franek Rozwadowki, the new Chief of Mission for Macedonia implored the government to "implement prudent fiscal and monetary policies, particularly on wages (which impact) the budget, employment, and growth." The government - facing elections in September that year - and the IMF failed to conclude a standby agreement for 2002-2003.

In another fragile corner of the globe, the Senate of Argentina, at the behest of the IMF, scrapped the 1974 Law of Economic Subversion often applied to foreign investors by the military junta and, more recently, by the courts. It was one of numerous conditions posed by the IMF in its negotiations with the embattled government. Later, Argentina defaulted on its obligations to the IMF and to other creditors and bondholders.

The Malawian authorities accused the IMF of "encouraging" the country to sell its strategic maize reserves at a 50 percent loss on the eve of crippling and famine-inducing crop shortages. The proceeds were to be used to pay off foreign commercial debts - claimed the Minister of Agriculture. The IMF denied any involvement and pointed the finger at both a food expert of the European Union - and the Malawi government.

In Uruguay - the hapless victim of Argentina's meltdown - the Fund supported a tripling of an existing loan to $2.2 billion. The IMF praised the government's unpopular hiking of taxes on salaries and pensions in the midst of a severe recession. It was the only way Uruguay could comply with its fiscal targets, it said.

The IMF was founded in 1944 by the nearly victorious allies. It reflects the lessons derived from the global depression that preceded and precipitated the conflagration. Its limited and crystal clear charter reads:

"The IMF was created to promote international monetary co-operation ; to facilitate the expansion and balanced growth of international trade; to promote exchange stability; to assist in the establishment of a multilateral system of payments; to make its general resources temporarily available to its members experiencing balance of payments difficulties under adequate safeguards; and to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members."

Like other Cold War structures - the IMF is an organization in search of a mission. It is more powerful, more controversial, more intrusive, more paternal, more coercive, more ubiquitous and more integrated with the US administration and other multilateral agencies and institutions than it has ever been. It has "invaded" the turf of other agencies and NGO's and appropriated some private sector functions as well.

In the process, it has exceeded its charter and its mandate by far and has transformed itself into a combination gigantic research institute, consultancy house, technical training facility, university, rating agency, supervisory authority, development bank, investment bank, and executive with sharply increased powers. Many resent this mission creep or feel threatened by it.

Others question the wisdom of such functional imperialism and its impact on the IMF and on its "clients" and shareholders - the nation-states. Doubts are voiced: is the IMF, this Byzantine bureaucracy, truly necessary? Can't the private sector take over many of its roles? The IMF's lack of transparency and accountability do not help.

It had to pass a special "transparency decision" in January 2001, calling for more thorough disclosure of its deliberations with member countries. Responding to the indignant outcry of NGO's and the private sector - the IMF has formed in 2002 an Internal Evaluation Unit. Yet, its inner processes, its finances, the inflated wages, perks and perquisites of its much feted and bloated bureaucracy - all remain alarmingly opaque.

As an example of the IMF's unexpected mutation, consider, for instance, its growing role in the regulation and surveillance of capital and financial markets throughout the world.

in May 2002, at the First Annual Forum of APEC's Finance and Development Program held in Beijing, the IMF's affable Deputy Managing Director, Shigemitsu Sugisaki, summed up the current philosophy of the lending agency:

"Our main priorities at the IMF have been on strengthening surveillance and crisis prevention. We cannot expect to eliminate all future crises, nor can we expect to be able to fully anticipate them. However, we can do a better job of reducing the risks of crises by promoting sound policies and the development of strong institutions by our member countries, as well as better risk assessments and investment decisions by market participants."

A new International Capital Markets Department keeps track of private capital flows, collaborates with other departments on assessment of vulnerabilities, on the monitoring of markets, forecasting, and the development of early warning systems. Sugisaki is unabashed about the IMF's role in providing investors with "a stronger basis to make judgments about the allocation of private capital" - hitherto the reserve of private sector rating agencies and global investment banks.

The IMF regularly issues Reports on the Observance of Standards and Codes (ROSC's) which cover "institutional issues, in particular on data dissemination, fiscal transparency, monetary and financial policy transparency, and financial sector issues". The IMF is collaborating with the OECD's FATF (Financial Action Task Force) on an anti-money laundering module.

This is only one of the Fund's institutional reform initiatives - hitherto tackled by the World Bank, NGO's, multilateral organizations (such as the UN), and bilaterally, between governments.

The Fund - jointly with the World Bank and other multilateral institutions - provides its members with a "Financial Sector Assessment Program" (FSAP) - a review of financial institutions, legislation, regulation, and supervision coupled with prescriptive measures to counter detected vulnerabilities. This review process covers also off shore money centers.

But the IMF is now competing head on not only with rating agencies and investment bankers - but also with regional development lenders and with its Bretton-Woods twin, the World Bank. IMF officials, rendered cynical by decades of friction with crime gangs thinly disguised as governments - consistently disparaged and mocked the feely-touchy, less than rigorous approach to lending of their World Bank counterparts.

To the citizens of many impoverished countries, who bear the brunt of its dogmatic austerity measures, the IMF is a repository of privileged and confidential information about their countries. It is unelected, unsupervised, misunderstood - yet, seemingly omnipotent and forever encroaching on often hard-earned sovereignty, like some sinister Medieval order.

In a dialog with Tom Rodwell, an Australian journalist, I wrote:

I was, therefore, startled to learn that the IMF's hallowed Executive Board has approved, on May 10, 2002 the Africa Capacity Building Initiative "in response to the urgent call by African leaders ... to strengthen economic governance and domestic capacity ... to carry out sound economic poverty-reducing policies."

Though presented as part of the IMF's ongoing technical assistance program - it is clearly and closely linked to political initiatives in Africa by the American administration - and to the New Partnership for Africa's Development, South Africa's pet project.

The World Bank and assorted donors - as well as the atrociously run African Development Bank - are supposed to act as equal partners. Still, the Initiative is clearly "owned" by the IMF. Its resident experts are slated to do the bulk of the arduous work. The IMF has, thus, firmly established itself in the hitherto excluded bureaucratic turf of development financing.

The argument against the IMF often revolves around two axes:

That it is a neo-colonialist institution, out to perpetuate the hegemony of rich countries over poorer ones - and that it is an impregnable fortress of outdated, inappropriate, even detrimental economic policies, collectively known as "The Washington Consensus".

The IMF is undoubtedly under undue political influence by the USA - which underwrites a quarter of its budget and hosts its headquarters. The recent spate of lending to Turkey and past excesses in Yeltsin's venal and mismanaged Russia are attributable to such American arm-twisting. The appointment, in early 2005, of a neo-conservative stalwart, Paul Wolfowitz, to head the IMF, is likely to exacerbate this incestuous relationship.

It is also true that the IMF is greatly concerned with its members' ability to service their external debt and, therefore, with the debt's size, sustainability, and sensitivity to fiscal and monetary policies. In this sense, the IMF is, indeed, the guardian of foreign creditors and their representative and enforcer. It so happens that most creditors are rich countries or banks and investors from the West.

But it would be nothing short of paranoid to postulate some kind of conspiracy, or colonial-mercantilist designs, or to claim, as the Canadian Prof. Michel Chussodowski does, that the IMF is a willing and cognizant instrument in the destruction of certain nations (e.g., Yugoslavia), or, generally, accuse it of other geopolitical machinations.

Few of the IMF's vocal anti-globalization opponents know that it deals as regularly and as strictly with its richer members - even those which do not require its assistance, advice, or intervention. On May 8, 2002, for instance, it concluded the mandatory Article IV consultation with Denmark.

The IMF explains Article IV thus:

"Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities."

The IMF sounded these cautionary notes about Denmark's generally much-praised economic policies:

A recent (April 2005) report castigated America's profligacy and the globally destabilizing effects of its alarming and ever-mushrooming twin (the trade and the budget) deficits.

While the conspiracy theories can be safely and off-handedly discarded - it is a lot more difficult to defend the IMF's policies. These consist of a universally-applied prescription of fiscal and monetary discipline, balanced budgets, a sustainable public debt, avoidance of moral hazard, restrained wage and expenditure policies, preference for the private sector, enhancement of the financial sector, structural reform, and exchange rate stability.

The IMF still sticks to the doctrine of a "nominal anchor": if not the exchange rate - than inflation targeting. The IMF concedes that the consensus is shifting towards more flexible exchange rate regimes in countries exposed to the global capital markets - but this is not supported by its policy advice.

The IMF's Deputy Managing Director, Shigemitsu Sugisaki hastened to stamp out this heresy in his address to the First Annual Forum of APEC's Finance and Development Program held in Beijing on May 26, 2002:

"Of course, this is not to say that, for certain economies, a pegged exchange rate regime, buttressed by the requisite supporting policies and institutions, cannot be a viable alternative. For such economies, in general, the harder and more rigid the peg, the better ... (Floating exchange rate regimes) do not imply a policy of benign neglect toward the exchange rate."

"For emerging market countries, with their high degree of involvement with global trade and finance, movements in exchange rates have important economic consequences, and economic policies, including monetary policy and exchange market intervention, need to take account of these movements." This is the oxymoron of "managed float".

The principles are commendable - their blind and doctrinarian implementation in the form of micromanaged conditionality - are not. The IMF - aware of its fast eroding public and political support, especially in the USA - has recently conjured up "country ownership" of agreed economic programs and "poverty reduction and growth facilities" - both intended to soothe jangling nerves. But these public relations exercises are auxiliary to its main thrust: fiscal rectitude, solvency, debt repayments.

Alas, many of these policies are ill-suited to the needs of failed or mismanaged states and the kleptocracies that rule them - the IMF's main clientele. While in "normal" countries macroeconomic stability is the prerequisite to long-term economic growth - this is not necessarily the case in the developing, emerging, and transition economies of sub-Saharan Africa, the Middle East, South Asia, East Europe, Central Asia, Latin America, or the Balkan.

Actually, too much stability may, in these benighted corners of the Earth, spell stagnation. Stability cannot translate to growth in the absence of functioning institutions, the rule of law, and properly rights. A dysfunctional banking system and rusted or clogged monetary transmission mechanisms render any monetary policy impotent.

A venal bureaucracy and graft-prone political class are likely to squander and misappropriate loans and grants - no matter how well intentioned and closely supervised. Finally, in the absence of a formal, entrepreneurial, and thriving private sector - only the state can provide a counter-cyclical impetus and the sole engine of growth is development-related and consumption-enhancing public spending. Public expenditures are the only functioning automatic stabilizer.

In this context, the classic argument of "public borrowing crowding out the private sector" is misplaced. Most of the private sector in these countries is informal. It does not compete in the credit markets with public borrowing - simply because there are no credit or capital markets to speak of. Interest rates are onerously high due to outlandish default rates - so, businesses borrow from each other, barter, and work in cash. Banks refuse to lend to businesses or households and thrive on arbitrage. Investment horizons are limited.

The IMF is obsessed with "exchange rate (and other nominal) anchors". It erroneously believes that - where all else is ominously fluid - only a predictable exchange rate (or inflation target) can guarantee stability. But this forces the government to adhere to constant policies of Procrustean fiscal contraction and thus exacerbate the anyhow depressed state of the economy. The alternative - fiscal expansion - would lead to pressure on the exchange rate peg and result in devaluation.

Yet, a pegged exchange rate in inflation-prone economies is tantamount to appreciation of the domestic currency - another form of instability. An overvalued currency coupled with deficient structural reforms and low productivity - adversely affect the country's terms of trade (i.e., its competitiveness in export markets).

This declining competitiveness, in turn, leads to trade deficits and a deteriorating balance of payment. Hence another IMF-inspired source of instability.  Thus, a regime of pegged exchange rates exacerbates both the duration and the degree of disequilibrium in the international balance of payments of the IMF's members.

The current account of a country that runs a gigantic balance of payments deficit but is not permitted by the IMF to devalue its currency - is only likely to deteriorate. Often, to protect the currency, the whole system is drained of liquidity (demonetized), interest rates are kept debilitatingly high, and the balance of payments deficit skyrockets, until the inevitable collapse.

Moreover, exchange (rate) stability inhibits the expansion and balanced growth of international trade - an explicit role of the IMF. Trade is based on dynamic exchange rate disparities which reflect the relative advantages of the countries involved. In a world of artificially fixed exchange rates - trade stagnates and price signals are distorted.

The IMF was never mandated to rate the creditworthiness of its members and shareholders. In providing clean or soiled bills of financial health it is manifestly acting ultra vires. Its ability to strangle a country financially if it does not comply with its programs - no matter what the social or economic costs are - is very worrying.

The IMF refuses to acknowledge that, far from being an exact science, economics is a branch of mass psychology and a form of social engineering. Not unlike previous central planning agencies, it neglects the social, political, and environmental costs of its policies. Yet, these sometimes outweigh the purely economic outcomes.

High interest rates stifle growth. An unrealistic exchange rate dampens exports. These effects are accounted for in the IMF's models. But there are other pernicious policy outcomes which the IMF consistently ignores - at the peril of the member countries:

Persistent unemployment breeds crime. Poverty results in civil strife. Taxes drive a growing part of the economy underground. Low wages in the public sector lead to venality and graft. Growing income inequalities foster discontent and brain drain. Different cultures possess different priorities, preferences, and values.

The IMF is indispensable. It  imposes monetary and fiscal discipline on unruly governments, forces them to plan ahead, and introduces painful adjustments and reforms as well as better governance. It serves as a convenient scapegoat: politicians blame it for their own shortcomings and misguided policies and claim that negotiations with the IMF and follow-up consume the bulk of their management time to little effect.

Finally, there is the Damocles sword of moral hazard. IMF lending of last resort is a safety net made available to countries "too big or too important to fail". It encourages politicians, creditors, and investors to assume risks they would not have otherwise, convinced of an ultimate bailout in case of failure. This certainty has been dented when the IMF refused to salvage Russia in 1998 and Argentina four years later - but it is still largely intact.

But there is a second type of moral hazard. When IMF-mandated policies succeed, local politicians hasten to take credit. When they fail - the IMF is universally derided. Thus, stakeholders - decision makers, reckless lenders, loss-prone investors, friendly governments, the citizenry - conveniently shift to Washington the blame for their own misdeeds and misbehavior.

This kind of buck passing is known in psychology as "alloplastic defenses" and is considered an integral part of some pathologies. Here, too, increased transparency and accessibility can help. The IMF needs to assertively point the finger and allocate blame when wrongly accused.

The IMF is lucky to be attacked either by anti-market fundamentalists, or by anti-IMF fanatics. Passionate emotions frequently produce ill-thought and unfounded arguments. Consider this exchange:

In a press briefing on May 16, 2002, Thomas Dawson, the Fund's Director of External Relations Department was asked by one of the journalists:

"I'd like to get your reaction to a prominent Nobel prize- winning economist (Joseph Stiglitz), who laid out an opinion last weekend, saying that the IMF's insistence on fiscal tightening in Argentina made things worse, and that the high rates of interest in Argentina were largely a function of external factors, such as the Asian financial crisis, and that the IMF's approach and the approach of others have amounted to blaming the victim."

He responded, thrashing the poor arguments of the distinguished - but biased - critic:

Indonesia's Minister of Development Planning called in May-June 2002 on his country to sever its ties with the "colonial power", the IMF, come November 2002, when its agreement with the lending agency expires. He blamed its coercive policies for the country's alleged near insolvency and civil disorder. Local bigwigs hastened to concur.

Lenders and donors often condition credits, debt reduction, and aid upon the IMF's seal of approval, in the form of a standby arrangement. Despite protestations to the contrary, cross-conditionality - including World Bank conditions in IMF programs and vice versa - is still rife.

Thus, inadvertently, the IMF has assumed in the last two decades the dual - and intimately related - roles of a sovereign credit risk rating agency and a lender of last resort - hitherto not among its core few and well-defined competencies.

Because other, non-IMF, financing is premised on its endorsement, the IMF carries disproportionate weight with governments and often leverages this stature to non-economic ends. From Moldova to Russia, the IMF has not been above meddling in domestic politics, though in the guise of "impartial advice" or "loan conditions to be met".

The IMF lends funds to countries in distress - e.g., to ameliorate a balance of payment or a capital account crisis (for instance, in Thailand in 1997), or a meltdown of the financial system (in Turkey last year). Such lending is predicated on a program ostensibly negotiated with the authorities - but, in practice, dictated by the IMF. The program provides detailed policy guidelines and performance evaluation benchmarks.

Yet, how reliable and realistic are these programs? Often produced in the throes of civil strife (Macedonia), currency collapse (Brazil), implosion of the banking system (Argentina), or natural and man-made disasters (Africa) - they tend to reflect mere wishful thinking and bureaucratic wrangles.

They are based on partial or fake figures provided by the kleptocracies that rule many of the IMF's most needy clients. Though mainly forward-looking (prospective) - IMF programs imply a modicum of certainty where there is none and are, thus, grossly misleading documents.

Rarely does the IMF admit that it is as much at a loss as its client government. In 2001 - as Albanians fought Macedonians in the outskirts of the capital, Skopje - The IMF suspended a previous program and placed Macedonia on "staff monitoring" - a euphemism for "let's wait and see how things turn out".

But these criticisms aside - the IMF is an important global center of scholarship and policy advice. It has made some contributions to the overhaul of the international financial architecture in train since 1998 - and is advocating controversial innovations such as national bankruptcy proceedings. Yet, is its advice sound and are its policies efficacious?

The IMF's prescriptive - and universally applied - policy mix displayed remarkable resilience in the face of global financial crises in the past decade. It includes: austerity measures, fiscal and monetary discipline, decreased inflation, balanced budgets, a sustainable public debt, avoidance of moral hazard, restrained wage and expenditure policies, preference for the private sector, the strengthening of the financial system, and structural reform.

In its recent past, the IMF advocated crippling competitive devaluations. This policy "recommendation" has now been replaced by either a pegged exchange rate - or a free floating rate coupled with an inflation target. These are known as "nominal anchors" and are supposed to guarantee economic stability and its inevitable outcome: economic growth.

The World Bank summarized the ten commandments of the Washington Consensus in its year 2000 Poverty Report thus:

1. 
   Fiscal discipline;
   
2. 
   Redirection of public expenditure toward education, health and infrastructure investment;
   
3. 
   Tax reform - broadening the tax base and cutting marginal tax rates;
   
4. 
   Interest rates that are market determined and positive (but moderate) in real terms;
   
5. 
   Competitive exchange rates;
   
6. 
   Trade liberalization - replacement of quantitative restrictions with low and uniform tariffs;
   
7. 
   Openness to foreign direct investment;
   
8. 
   Privatization of state enterprises;
   
9. 
   Deregulation - abolition of regulations that impede entry or restrict competition, except or those justified on safety, environmental and consumer protection grounds, and prudential oversight of financial institutions;
   
10. 
    Legal security for property rights.
    

The IMF deviates from its catechism only when instructed to do so by its paymaster, the USA. Thus, Stratfor, the American strategic forecasting firm, noted the schizophrenic behaviour of the IMF. Under fairly similar circumstances, it chose to lend to Turkey, a crucial US ally - but not to Argentina. The IMF's new African poverty reduction initiative carries the fingerprints of the American administration as well.

Most strikingly, in line with the much proclaimed US positions, and contrary to everything the IMF has ever preached, it encourages Japan to slash its taxes even further while increasing its public spending, and, by implication, its crushing and unsustainable public debt and gaping budget deficit.

But these are aberrations. Moreover, even the orthodoxy of the "Washington Consensus" is not all wrong. The faults of the IMF's policies run deeper and can be traced to its modus operandi and raison d'etre.

First, though much reduced, some IMF "crisis" lending is concessionary - soft loans, at subsidized interest rates, with sizable grace periods. This fosters moral hazard and encourages imprudent behavior. Walter Bagehot, the legendary 19th editor of "The Economist", advised lenders of last resort to lend freely but at a penalty rate and against collateral.

Charles Calomiris and Allan Meltzer follow this sound advice in their Summer 1999 article published in "National Affairs" and titled "Fixing the IMF":

The second fundamental problem is that IMF programs exclusively tackle national "balance sheets" - budget deficits, inflation, and public debt. The implicit assumption is that the smaller and more thrifty the state - the better off its citizenry. This principle invariably holds true in rich and well-governed countries.

Not so in developing, emerging, and transition economies. Here, the better the national accounts - the worst off the inhabitants. Unemployment, social tensions, and poverty grow as macroeconomic parameters "improve". Income and wealth inequalities soar and the middle class evaporates to the detriment of the country's political stability.

This inversion is due to arthritic monetary transmission mechanisms - and to the absence of a private sector. The economic engine in such destitute countries is the state. Public spending takes the place of capital formation and generates consumption. The savings level is largely immaterial because financial intermediaries fail to transform it into investments. Thus, the curbing of the state's involvement in the economy has an adverse and prolonged recessionary impact.

The third perverse trend is the crowding-out of private sector or bilateral capital flows by multilateral debt. The share of IMF and World Bank lending in the total public debt of developing countries has quintupled in the last two decades. The money is mostly used to repay creditors - multilateral, bilateral, and private sector (i.e., banks). Thus, the increase in the total indebtedness of borrowing countries serves to bail out stranded lenders - but does little to foster economic growth and development.

The IMF's biggest problem by far may be that it strayed way out of its - ostensible - competency. It is reasonably qualified to deal with fiscal matters, the financial system, and monetary issues with emphasis on the exchange rate regime. It is an absolute dilettante when it comes to reform - structural or otherwise.

"The Reality of Aid 2002", a report produced by a coalition of NGO's, charges that:

"Far from abandoning aid conditionality, international financial institutions and bilateral donors are collaborating in an unprecedented consensus to retool the aid regime under the rubric of 'ownership' and aid effectiveness."

The IMF itself admits, in its February 2001 report, "Structural Adjustment Conditionality in Fund-Supported Programs", to an average of 41 conditions per agreement concluded between 1995-2000. Independent scholars, such as Nancy Alexander, found 114 conditions in a typical program in sub-Saharan Africa in 1999.

The International Confederation of Free Trade Unions (ICFTU) cites the example of Romania's November 2001 standby  arrangement with the IMF. It included conditions pertaining to the liberalization of domestic energy prices, privatization, and the restructuring of state-owned enterprises. Macedonia was required by the IMF to sell or shut down its loss-making state enterprises as a condition for any agreement with the Fund.

This control freakery coupled with micromanagement of the minutest details of both the economic and social policies of recipient-countries is counter-productive. The IMF personnel are poorly qualified to dole out policy advice on these issues. They compensate for insecurity with haughtiness. As a result, the IMF's clients are alienated and angered by its conduct.

They regard the Fund's programs as external and sinister impositions and at best ignore parts of it. The dual concepts of "ownership" and "aid effectiveness" are rendered shams by this overweening attitude. What could have been a partnership between indigenous reformists and well-meaning, knowledgeable, foreigners - is frequently transformed into a xenophobic tug of war.

The tenets of the Washington Consensus are no longer confined to arcane provisos in IMF and World Bank programs. They are now the pillars of a new regime of international law. They are embedded in the charter of the World Trade Organization, for instance - a quasi-judiciary body as well as a regulator of international trade and much more besides.

In many respects, therefore, the IMF survived the 1997-8 crisis to prosper and become more potent than ever. Hence, perhaps, the backlash by well-meaning but often ignorant and impractical anti-globalizers and assorted self-appointed NGO's. To its credit, the IMF is not ignoring them. It is trying to maintain a meaningful dialog. But its survival is not premised on the success of such a discourse - as it was once thought to be.

Footnote - Ann Kruger's SDRM plan

The IMF is, in a way, a lender of last resort. When a country seeks IMF financing, its balance of payments is already ominously stretched, its debt shunned by investors, and its currency under pressure. Put differently, the IMF's active clients are effectively illiquid (though never insolvent in the strict sense of the word). Anne Krueger's November 2001 proposal to allow countries to go bankrupt makes, therefore, eminent sense.

Today, sovereign debt defaults result in years of haggling among bankers and bondholders. It is a costly process, injurious to the distressed country's future ability to borrow. The terms agreed are often onerous and, in many cases, lead to a second event of default. The experiences of Argentina, Ukraine, and Ecuador are instructive. Russia - another serial debt restructurer - would have been in a far worse pickle were it not for the serendipitous surge in oil prices.

A carefully thought-out international sovereign bankruptcy procedure is likely to yield two important results:

1. 
   It will relegate to the marketplace many tricky issues now tackled by a politically-compromised and bloated IMF.
   
2. 
   It will eliminate the ability of a single creditor to blackmail all the others - and the debtor - into an awkward deal (the "last man syndrome).
   

Still, the analogy is partly misleading. What if a developing country abuses the bankruptcy procedures? As "The Economist" noted correctly "an international arbiter can hardly threaten to strip a country of its assets, or forcibly change its 'management'".

Yet, this is precisely where market discipline comes in. A rogue debtor can get away with legal shenanigans once - but it is likely to be shunned by lenders henceforth. Good macroeconomic policies are bound to be part and parcel of any package of debt rescheduling and restructuring in the framework of a sovereign bankruptcy process.

Immigration (and Labor)

Jean-Marie Le Pen - France's dark horse presidential contender - is clearly emotional about the issue of immigration and, according to him, its correlates, crime and unemployment. His logic is dodgy at best and his paranoid xenophobia ill-disguised. But Le Pen and his ilk - from Carinthia to Copenhagen - succeeded to force upon European mainstream discourse topics considered hitherto taboos. For decades, the European far right has been asking all the right questions and proffering all the far answers.

Consider the sacred cow of immigration and its emaciated twin, labour scarcity, or labour shortage.

Immigrants can't be choosy. They do the dirty and dangerous menial chores spurned by the native population. At the other extreme, highly skilled and richly educated foreigners substitute for the dwindling, unmotivated, and incompetent output of crumbling indigenous education systems in the West. As sated and effete white populations decline and age, immigrants gush forth like invigorated blood into a sclerotic system.

According to the United Nations Population Division, the EU would need to import 1.6 million migrant workers annually to maintain its current level of working age population. But it would need to absorb almost 14 million new, working age, immigrants per year just to preserve a stable ratio of workers to pensioners.

Similarly hysterical predictions of labour shortages and worker scarcity abounded in each of the previous three historic economic revolutions.

As agriculture developed and required increasingly more advanced skills, the extended family was brutally thrust from self-sufficiency to insufficiency. Many of its functions - from shoemaking to education - were farmed out to specialists. But such experts were in very short supply. To overcome the perceived workforce deficiency, slave labour was introduced and wars were fought to maintain precious sources of "hands", skilled and unskilled alike.

Labour panics engulfed Britain - and later other industrialized nations such as Germany - during the 19th century and the beginning of the twentieth.

At first, industrialization seemed to be undermining the livelihood of the people and the production of "real" (read: agricultural) goods. There was fear of over-population and colonial immigration coupled with mercantilism was considered to be the solution.

Yet, skill shortages erupted in the metropolitan areas, even as villages were deserted in an accelerated process of mass urbanization and overseas migration. A nascent education system tried to upgrade the skills of the newcomers and to match labour supply with demand. Later, automation usurped the place of the more expensive and fickle laborer. But for a short while scarce labour was so strong as to be able to unionize and dictate employment terms to employers the world over.

The services and knowledge revolutions seemed to demonstrate the indispensability of immigration as an efficient market-orientated answer to shortages of skilled labour. Foreign scientists were lured and imported to form the backbone of the computer and Internet industries in countries such as the USA. Desperate German politicians cried "Kinder, not Inder" (children, not Indians) when chancellor Schroeder allowed a miserly 20,000 foreigners to emigrate to Germany on computer-related work visas.

Sporadic, skill-specific scarcities notwithstanding - all previous apocalyptic Jeremiads regarding the economic implosion of rich countries brought on by their own demographic erosion - have proven spectacularly false.

Some prophets of doom fell prey to Malthusian fallacies. According to these scenarios of ruination, state pension and health obligations grow exponentially as the population grays. The number of active taxpayers - those who underwrite these obligations - declines as more people retire and others migrate. At a certain point in time, the graphs diverge, leaving in their wake disgruntled and cheated pensioners and rebellious workers who refuse to shoulder the inane burden much longer. The only fix is to import taxable workers from the outside.

Other doomsayers gorge on "lumping fallacies". These postulate that the quantities of all economic goods are fixed and conserved. There are immutable amounts of labour (known as the "lump of labour fallacy"), of pension benefits, and of taxpayers who support the increasingly insupportable and tenuous system. Thus, any deviation from an infinitesimally fine equilibrium threatens the very foundations of the economy.

To maintain this equilibrium, certain replacement ratios are crucial. The ratio of active workers to pensioners, for instance, must not fall below 2 to 1. To maintain this ratio, many European countries (and Japan) need to import millions of fresh tax-paying (i.e., legal) immigrants per year.

Either way, according to these sages, immigration is both inevitable and desirable. This squares nicely with politically correct - yet vague - liberal ideals and so everyone in academe is content. A conventional wisdom was born.

Yet, both ideas are wrong. These are fallacies because economics deals in non-deterministic and open systems. At least nine forces countermand the gloomy prognoses aforementioned and vitiate the alleged need for immigration:

I. Labour Replacement

Labour is constantly being replaced by technology and automation. Even very high skilled jobs are partially supplanted by artificial intelligence, expert systems, smart agents, software authoring applications, remotely manipulated devices, and the like. The need for labour inputs is not constant. It decreases as technological sophistication and penetration increases. Technology also influences the composition of the work force and the profile of skills in demand.

As productivity grows, fewer workers produce more. American agriculture is a fine example. Less than 3 percent of the population are now engaged in agriculture in the USA. Yet, they produce many times the output produced a century ago by 30 percent of the population. Per capita the rise in productivity is even more impressive.

II. Chaotic Behaviour

All the Malthusian and Lumping models assume that pension and health benefits adhere to some linear function with a few well-known, actuarial, variables. This is not so. The actual benefits payable are very sensitive to the assumptions and threshold conditions incorporated in the predictive mathematical models used. Even a tiny change in one of the assumptions can yield a huge difference in the quantitative forecasts.

The doomsayers often assume a static and entropic social and economic environment. That is rarely true, if ever. Governments invariably influence economic outcomes by providing incentives and disincentives and thus distorting the "ideal" and "efficient" market. The size of unemployment benefits influences the size of the workforce. A higher or lower pension age coupled with specific tax incentives or disincentives can render the most rigorous mathematical model obsolete.

At a labour force participation rate of merely 60% (compared to the USA's 70%) - Europe still has an enormous reservoir of manpower to draw on. Add the unemployed - another 8% of the workforce - to these gargantuan numbers - and Europe has no shortage of labour to talk of. These workers are reluctant to work because the incentive structure is titled against low-skilled, low-pay, work. But this is a matter of policy. It can be changed. When push comes to shove, Europe will respond by adapting, not by perishing, or by flooding itself with 150 million foreigners.

The role of international trade - now a pervasive phenomenon - is oft-neglected. Trade allows rich countries to purchase the fruits of foreign labour - without importing the laborers themselves. Moreover, according to economic theory, trade is preferable to immigration because it embodies the comparative advantages of the trading parties. These reflect local endowments.

Modern economies are comprised 70% of services and are sustained by vast networks of telecommunications and transport. Advances in computing allow to incorporate skilled foreign workers in local economic activities - from afar. Distributed manufacturing, virtual teams (e.g., of designers or engineers or lawyers or medical doctors), multinationals - are all part of this growing trend. Many Indian programmers are employed by American firms without ever having crossed the ocean or making it into the immigration statistics.

Demographic trends are not linear. They resemble the pattern, borrowed from evolutionary biology, and known as "punctuated equilibrium". It is a fits and starts affair. Baby booms follow wars or baby busts. Demographic tendencies interact with economic realities, political developments, and the environment.

Social trends are even more important than demographic ones. Yet, because they are hard to identify, let alone quantify, they are scarcely to be found in the models used by the assorted Cassandras and pundits of international development agencies. Arguably, the emergence of second and third careers, second families, part time work, flextime, work-from-home, telecommuting, and unisex professions have had a more decisive effect on our economic landscape than any single demographic shift, however pronounced.

Immigration may contribute to growing mutual tolerance, pluralism, multiculturalism, and peace. But there is no definitive body of evidence that links it to economic growth. It is easy to point at immigration-free periods of unparalleled prosperity in the history of nations - or, conversely, at recessionary times coupled with a flood of immigrants.

So, is Le Pen right?

Only in stating the obvious: Europe can survive and thrive without mass immigration. The EU may cope with its labour shortages by simply increasing labour force participation. Or it may coerce its unemployed (and women) into low-paid and 3-d (dirty, dangerous, and difficult) jobs. Or it may prolong working life by postponing retirement. Or it may do all the above - or none. But surely to present immigration as a panacea to Europe's economic ills is as grotesque a caricature as Le Pen has ever conjured.

The quality of Wall Street research has suffered grievous blows these last two years. Yet, publishers of political and economic indices largely escaped unscathed. Though their indicators often influence the pecuniary fate of developing countries, they are open to little scrutiny and criticism.

The Heritage Foundation and the Wall Street Journal are the joint publishers of the 2002 edition of the much-vaunted "Index of Economic Freedom". The annual publication purports to measure and compare the level of economic freedoms in 155 countries.

According to its Web site, the Index takes into account these factors:

• 
  Corruption in the judiciary, customs service, and government bureaucracy;
  
• 
  Non-tariff barriers to trade, such as import bans and quotas as well as strict labeling and licensing requirements;
  
• 
  The fiscal burden of government, which encompasses income tax rates, corporate tax rates, and government expenditures as a percent of output;
  
• 
  The rule of law, efficiency within the judiciary, and the ability to enforce contracts;
  
• 
  Regulatory burdens on business, including health, safety, and environmental regulation;
  
• 
  Restrictions on banks regarding financial services, such as selling securities and insurance;
  
• 
  Labor market regulations, such as established work weeks and mandatory separation pay; and
  
• 
  Black market activities, including smuggling, piracy of intellectual property rights, and the underground provision of labor and other services.
  

Macedonia's GDP is $3.4 billion and not $2.7 billion as the report states. Macedonia's GDP exceeded $3 billion in the last 4 years. Nor has GDP grown by 2.7 percent last year or the year before. In 2001, it has actually declined by 4.3 percent and is likely to decline again or rise a little this year. As a result, GDP per capita is wrongly computed. The trade deficit is not $300 million - but double that. It has been above $500 for the last few years. Net foreign direct investment has been closer to $100 million for two years now - rather than the paltry $29 million the report misreports.

The report makes "rice" one of Macedonia's "major" agricultural products. It is, actually, first on its list. Alas, little rice is grown in Macedonia nowadays, though it did use to be a weighty European rice grower decades ago. Nor does the country produce noticeable quantities of citrus, or grains, as the report would have us believe.

The authoritative-sounding introduction to the chapter informs us that Macedonia maintains a budget surplus "from the sale of state-owned telecommunications". In its decade of existence, Macedonia enjoyed a budget surplus only in 2000 and it had nothing to do with the sale of its telecom to the German-Hungarian MATAV. The proceeds of this privatization were kept in a separate bank account. Only a small part was used for budgetary and balance of payment purposes.

The outgoing prime minister would be pleasantly astounded to learn that he "privatized approximately 90 percent of (the country's) state-owned firms". These were actually privatized by the opposition when it was in power until 1998. It is true that major assets, such as Macedonia's refinery and its leading bank, were privatized in the last 4 years. It is also true that the bulk of state-owned loss making enterprises were either sold or shut. But these constitute less than 15 percent of the number of companies the state owned in 1992.

The fiscal burden of Macedonia is 34 percent of GDP - not 23 percent as is the impression that section provides. It has surpassed 30 percent of GDP long ago. Moreover, in the sub-chapter titled "Fiscal Burden of the Government" the authors contend that "government expenditures equaled 23.3 percent of GDP". A mere three lines later fiscal rectitude sets in and  "the government consumes 19 percent of GDP". Which is it?

The "monetary policy" segment is a misleading one-liner: "Between 1993 and 2000, Macedonia's weighted annual average rate of inflation was 7.15 percent." The term "weighted annual average rate of inflation" is not explained anywhere in the tome. Whatever it is, this average masks the hyperinflation of Macedonia's first half decade and the near deflation of the last few years. The straight average in this period was 56 percent, not 7 percent.

The report says that "the country's political instability has had a debilitating effect on foreign investment". It sounds logical but does not stand up to scrutiny. Investment flows actually increased in the conflict year as bargain hunters from Greece, Slovenia, Germany, and other countries converged on Macedonia.

And so it continues.

Macedonia is a tiny and unimportant country. Clearly, scarce research resources are better allocated to Russia or Indonesia. But many of the erroneous data quoted in the report would have required a single surfing session to amend. Sloppy editing, internal contradictions, and outdated information regarding one country, regardless of how inconsequential it is, render the entire opus suspicious.

Unfortunately, indices such as these affect both portfolio and direct investment flows, the country's rating, its image in the international media, and the government's standing domestically. The golden rule with such a responsibility is "handle with care". Regrettably, few do.

Inefficiency (Market)

Even the most devout proponents of free marketry and hidden hand theories acknowledge the existence of market failures, market imperfections and inefficiencies in the allocation of economic resources. Some of these are the results of structural problems, others of an accumulation of historical liabilities. But, strikingly, some of the inefficiencies are the direct outcomes of the activities of "non bona fide" market participants. These "players" (individuals, corporations, even larger economic bodies, such as states) act either irrationally or egotistically (too rationally).

What characterizes all those "market impeders" is that they are value subtractors rather than value adders. Their activities generate a reduction, rather than an increase, in the total benefits (utilities) of all the other market players (themselves included). Some of them do it because they are after a self interest which is not economic (or, more strictly, financial). They sacrifice some economic benefits in order to satisfy that self interest (or, else, they could never have attained these benefits, in the first place). Others refuse to accept the self interest of other players as their limit. They try to maximize their benefits at any cost, as long as it is a cost to others. Some do so legally and some adopt shadier varieties of behaviour. And there is a group of parasites – participants in the market who feed off its very inefficiencies and imperfections and, by their very actions, enhance them. A vicious cycle ensues: the body economic gives rise to parasitic agents who thrive on its imperfections and lead to the amplification of the very impurities that they prosper on.

We can distinguish six classes of market impeders:

1. 
   Crooks and other illegal operators. These take advantage of ignorance, superstition, greed, avarice, emotional states of mind of their victims – to strike. They re-allocate resources from (potentially or actually) productive agents to themselves. Because they reduce the level of trust in the marketplace – they create negative added value. (See: "The Shadowy World of International Finance" and "The Fabric of Economic Trust")
   

2. 
   Illegitimate operators include those treading the thin line between legally permissible and ethically inadmissible. They engage in petty cheating through misrepresentations, half-truths, semi-rumours and the like. They are full of pretensions to the point of becoming impostors. They are wheeler-dealers, sharp-cookies, Daymon Ranyon characters, lurking in the shadows cast by the sun of the market. Their impact is to slow down the economic process through disinformation and the resulting misallocation of resources. They are the sand in the wheels of the economic machine.
   

3. 
   The "not serious" operators. These are people too hesitant, or phobic to commit themselves to the assumption of any kind of risk. Risk is the coal in the various locomotives of the economy, whether local, national, or global. Risk is being assumed, traded, diversified out of, avoided, insured against. It gives rise to visions and hopes and it is the most efficient "economic natural selection" mechanism. To be a market participant one must assume risk, it in an inseparable part of economic activity. Without it the wheels of commerce and finance, investments and technological innovation will immediately grind to a halt. But many operators are so risk averse that, in effect, they increase the inefficiency of the market in order to avoid it. They act as though they are resolute, risk assuming operators. They make all the right moves, utter all the right sentences and emit the perfect noises. But when push comes to shove – they recoil, retreat, defeated before staging a fight. Thus, they waste the collective resources of all that the operators that they get involved with. They are known to endlessly review projects, often change their minds, act in fits and starts, have the wrong priorities (for an efficient economic functioning, that is), behave in a self defeating manner, be horrified by any hint of risk, saddled and surrounded by every conceivable consultant, glutted by information. They are the stick in the spinning wheel of the modern marketplace.
   

1. 
   The former kind of operators obviously has a character problem. Yet, there is a more problematic species: those suffering from serious psychological problems, personality disorders, clinical phobias, psychoneuroses and the like. This human aspect of the economic realm has, to the best of my knowledge, been neglected before. Enormous amounts of time, efforts, money and energy are expended by the more "normal" – because of the "less normal" and the "eccentric". These operators are likely to regard the maintaining of their internal emotional balance as paramount, far over-riding economic considerations. They will sacrifice economic advantages and benefits and adversely affect their utility outcome in the name of principles, to quell psychological tensions and pressures, as part of obsessive-compulsive rituals, to maintain a false grandiose image, to go on living in a land of fantasy, to resolve a psychodynamic conflict and, generally, to cope with personal problems which have nothing to do with the idealized rational economic player of the theories. If quantified, the amounts of resources wasted in these coping manoeuvres is, probably, mind numbing. Many deals clinched are revoked, many businesses started end, many detrimental policy decisions adopted and many potentially beneficial situations avoided because of these personal upheavals.
   

5. 
   Speculators and middlemen are yet another species of parasites. In a theoretically totally efficient marketplace – there would have been no niche for them. They both thrive on information failures. The first kind engages in arbitrage (differences in pricing in two markets of an identical good – the result of inefficient dissemination of information) and in gambling. These are important and blessed functions in an imperfect world because they make it more perfect. The speculative activity equates prices and, therefore, sends the right signals to market operators as to how and where to most efficiently allocate their resources. But this is the passive speculator. The "active" speculator is really a market rigger. He corners the market by the dubious virtue of his reputation and size. He influences the market (even creates it) rather than merely exploit its imperfections. Soros and Buffet have such an influence though their effect is likely to be considered beneficial by unbiased observers. Middlemen are a different story because most of them belong to the active subcategory. This means that they, on purpose, generate market inconsistencies, inefficiencies and problems – only to solve them later at a cost extracted and paid to them, the perpetrators of the problem. Leaving ethical questions aside, this is a highly wasteful process. Middlemen use privileged information and access – whereas speculators use information of a more public nature. Speculators normally work within closely monitored, full disclosure, transparent markets. Middlemen thrive of disinformation, misinformation and lack of information. Middlemen monopolize their information – speculators share it, willingly or not. The more information becomes available to more users – the greater the deterioration in the resources consumed by brokers of information. The same process will likely apply to middlemen of goods and services. We are likely to witness the death of the car dealer, the classical retail outlet, the music records shop. For that matter, inventions like the internet is likely to short-circuit the whole distribution process in a matter of a few years.
   

6. 
   The last type of market impeders is well known and is the only one to have been tackled – with varying degrees of success by governments and by legislators worldwide. These are the trade restricting arrangements: monopolies, cartels, trusts and other illegal organizations. Rivers of inks were spilled over forests of paper to explain the pernicious effects of these anti-competitive practices (see: "Competition Laws"). The short and the long of it is that competition enhances and increases efficiency and that, therefore, anything that restricts competition, weakens and lessens efficiency.
   

This picture of "laissez faire, laissez aller" should be complimented by even stricter legislation coupled with effective and draconian law enforcement agents and measures. The illegal and the illegitimate should be stamped out, cruelly. Freedom to all – is also freedom from being conned or hassled. Only when the righteous freely prosper and the less righteous excessively suffer – only then will we have entered the efficient kingdom of the free market.

This still does not deal with the "not serious" and the "personality disordered". What about the inefficient havoc that they wreak? This, after all, is part of what is known, in legal parlance as: "force majeure".