The IMF and the Return of Structural Conditionality in Europe

The IMF has increased in importance over the last few years, especially in Europe.  Prof. Joyce writes on the background of its evolution.

by Joseph P. Joyce  is a Professor of Economics at Wellesley College and the Faculty Director of the Madeleine Korbel Albright Institute for Global Affairs.

The IMF and the Return of Structural Conditionality in Europe
(March 2012)

In 2002, the IMF promised to reduce the use of structural policies in the policy conditions attached to its lending programs. Recently, however, the IMF has incorporated structural measures into the programs for some of its European borrowers. The shift in emphasis is based on the IMF’s judgment of the need to promote growth in these economies. The IMF’s evaluation of the appropriate policies reveals a split with the other members of the governing “troika,” the European Commission (EC) and the European Central Bank (ECB), which have emphasized short-term fiscal austerity. The difference in views over what needs to be done to achieve sustainable debt positions may hinder the recovery of these countries.

Structural conditions were introduced in the 1980s to improve the allocation of resources through the use of market mechanisms in order to raise economic growth rates. Among the measures included in the IMF’s lending programs were the deregulation of private markets, the privatization of state-owned enterprises, and the reform of the civil service and labor markets. The IMF reported in 2001 that by the mid-1990s, nearly all of its lending arrangements contained some structural conditions, and that the number of such conditions per program had risen.

The use of structural conditionality, however, was sharply criticized, and was viewed as particularly inappropriate for countries that faced financial crises that reflected the “sudden stop” of short-term capital flows. The experiences of China and other Asian countries were cited as evidence that there were alternative paths to growth. After the pledged to rely on the principle of parsimony by focusing on the core areas of its expertise, i.e., monetary, fiscal and exchange rate policies and issues related to the financial sector, and reducing the number of conditions. 

The IMF conducted a review of its compliance with the new guidelines in 2005. Its report found that the scope of structural conditionality had been narrowed, but there had been no reduction in the number of conditions. Similarly, the IMF’s own Independent Evaluation Office (IEO) undertook a review of structural conditionality in 2007. This report also observed that the Fund had limited the focus of its conditionality, but that there had been little change in the number of conditions. In 2009 the IMF eliminated structural performance criteria as a tool of assessing compliance with a program’s conditions, although structural reforms can be included in an overall review of program performance.
The IMF recently concluded its latest evaluation of its conditionality (IMF 2012a, IMF 2012b). The Fund’s review claims that its use of conditionality became more parsimonious during the period under review, 2002 through September 2011. The number of conditions attached to the Fund’s program fell, while the focus was confined to the core areas of the IMF’s responsibility. But the report also acknowledged that the number of conditions rose in programs undertaken at the end of the period, including the programs in Europe.

A close examination of the IMF’s programs for Greece and Portugal demonstrates how structural measures have been incorporated into their programs. Greece received a three-year Stand-By Arrangement for SDR 26.4 billion (about €30 billion or $40 billion) in 2010, but that program was replaced in 2012 by a four-year Extended Fund Facility Arrangement for SDR 23.8 billion (€28 billion or $36.7 billion) after many of the original plan’s targets were missed. At the end of last year there was an IMF review of the progress to date under the new Greek program.

This review noted that Greece’s fiscal and external imbalances are improving, but its substantial economic contraction has continued. The IMF found that the structural transformation of economy is proceeding at a slow place outside of the labor market, “…and this is making Greece’s adjustment more costly.” There was agreement with the Greek authorities that “…structural reforms to date had been uneven at best, and that a reinvigoration of the reform agenda would be critical to boost potential growth.”

The review cited a lack of movement in deregulating product markets by removing barriers to entry. The privatization of state-owned assets was another area of major concern, since the targets that had been set “…have been missed by a wide margin”, in part because of political resistance. The IMF acknowledged that the reform of Greek labor markets had been initiated, but called for further measures, such as the implementation of a new minimum wage system. The liberalization of entry to regulated professions also needed to be advanced.

Structural policies are also a part of the lending program extended to Portugal, which borrowed SDR 23.74 (€26 billion or $39 billion) through a three-year Extended Fund Facility in May 2011. A recent IMF review of Portugal’s record in the program found that structural reforms have been advanced, and gave these efforts some of the credit for the decline in Portuguese government bond yields. The government has moved to tackle excessive regulatory procedures, and adapt wage bargaining to allow differences in wages across sectors. A number of judicial reforms are also underway. But the IMF’s staff worried that “…it remains unclear whether reforms to date are sufficient to address the large external competitiveness gap or will engender an adequately strong supply response to avoid a prolonged demand-driven slump.”

Greece and Portugal are not the only European countries to have borrowed from the IMF in recent years. In 2008-09, the IMF lent to Hungary, Latvia, Romania and Serbia. These loans were extended to mitigate the impact of the global financial shock that had begun in the U.S. The borrowers did not require extensive conditionality, although there were measures to strengthen their financial sectors, particularly in the case of Iceland. Ireland accepted SDR 19.5 billion (€22.5 billion or $30.1 billion) from the IMF in the form of a three-year Extended Fund Facility in 2010. Its need for assistance was attributed to the excessive bank lending that took place preceding the global crisis rather than any structural economic shortcomings. Cyprus will also require extensive financial restructuring.

The IMF’s programs to Greece and Portugal are part of larger programs that included loans from the other European governments, which are monitored by the EC. In the past, the IMF focused on macroeconomic policies while the EC dealt with structural reforms. But, the IMF admits in its overview of conditionality,

“Over time, both the Fund and the EC have increasingly ventured into areas of structural reforms initially devoted to the other institution. EC-supported measures have been more and more focused on fiscal issues, while the Fund introduced “competitiveness” conditionality in the Portugal and Greece programs.”

The IMF has taken a different perspective of what steps need to be taken in Europe than have the EC and the ECB, a divergence that began during the global financial crisis.  In the cases of Greece and Portugal, the IMF supports fiscal adjustment while seeking to reverse their economic contractions with structural measures. But the EC has insisted on short-term austerity that could actually worsen their debt positions. 

The different time frames and policy assessments of the IMF and the Europeans are exacerbating the situation of these countries. Political opposition to the fiscal cutbacks slows adoption of structural measures and hinders the growth that the IMF seeks to promote. Moreover, the split between the members of the “troika” does not bode well for future joint programs, even as the case of Cyprus demonstrates that there will be continued need for institutional collaboration.