Calling the tune: when the International Monetary Fund lends money to a country with a troubled economy, the borrower has to undertake some often-painful reforms.

By the mid-1980s, the return to laissez-faire capitalism was well under way and its principles became part of the culture of the Bretton Woods Sisters. Those guiding the World Bank and the IMF saw governments as one reason why their development efforts were falling short of targets. In many developing nations, corrupt officials were skimming development money. Government officials in other countries lacked the training and resources to administer programs. Some of the top people at the World Bank and the IMF thought they were, in too many cases, shovelling loans into a black hole. It was time to apply some of the discipline of the free market to the institutions and their clients alike.

So, the IMF asks "What's the point of pulling a country out of the glue if the country doesn't deal with the problems that got it into the glue in the first place?"

The IMF prescription for solving economic problems is always a variation on the same theme. Sell government-owned businesses to the private sector, remove controls on the flow of capital into and out of the country, abandon subsidies to, and tariff protection of, domestic industries, reduce regulations that hinder the operations of free enterprise, and cut government spending.

All together, this prescription for curing an ailing economy is called a Structural Adjustment Program (SAP) and it's the lightning rod for criticism of the World Bank and the IMF.

Governments from developing countries don't seek IMF financial assistance when the sun is shining; they ask for help when they have already run into an economic storm, generally through some combination of bad management and bad luck.

Let's look at Ecuador as an example of how structural adjustment works in the real world.

The country is on the west coast of South America and it straddles the Equator, from which it takes its name (Ecuador is the Spanish word for "equator"). It has a population of about 13 million living in an area a little less than half the size of Manitoba. The capital is Quito.

In 1972, Ecuador began exporting oil. This brought in valuable foreign investment and created a decade of prosperity and rapid economic growth. The downside was that most of the wealth went into the hands of the already well off, while the large number of poor people remained poor. The increased incomes of those with money led to imports of consumer goods. This, in turn, caused Ecuador's foreign debt to rise rapidly.

In the early 1980s, the world economy turned sour, cutting the demand for oil. Then, Nature dealt Ecuador a couple of blows with bad floods in 1983 and a devastating earthquake in 1987.

By now, the country's foreign debt had ballooned to $9 billion and the government stopped making payments on it. For the next ten years, Ecuador lurched along through a succession of ineffective governments. Corruption was rampant with one vice-president doing a runner just ahead of his arrest for stealing from the national treasury.

Then, Mother Nature got bad tempered again. Changes in the El Nino ocean current severely damaged crops in 1997 and 1998. A drop in world oil prices in the late 1990s reduced the national income from petroleum production. In addition, a financial collapse in Asian economies in 1997 caused an economic slowdown in Ecuador and many other South American countries. Many of Ecuador's banks faced collapse due to the economic downturn.

Under pressure from international financial institutions, Ecuador's government started to apply the corrective measures outlined in the Washington Consensus (see sidebar). Gasoline and electricity subsidies were eliminated; there were plans to cut the number of government employees and to sell state-owned companies. Strikes and riots persuaded President Jamil Mahuad to soften the tough measures. But, the economy went deeper into the soup, inflation stayed high, Ecuador's currency, the sucre, lost almost all its value, and, in September 1999, the government failed to make payments on its foreign debts.

In January 2000, the military ousted President Mahuad and replaced him with Vice President Gustavo Noboa. Ecuador then adopted the U.S. dollar as its national currency and welcomed more foreign investment into its oil, electricity, and telecommunications industries. The International Monetary Fund announced a $2 billion aid package for Ecuador. The IMF came up with 167 reforms the country had to implement to qualify for the financial assistance.

Linda McQuaig in her 2001 book, All You Can Eat picks up the story. "Under the IMF plan," wrote Ms. McQuaig, "the government of Ecuador had to fire or otherwise eliminate 26,000 employees from its payroll, and then cut by half the real wages of those remaining. The IMF's plan also required that the country's biggest water system be taken over by private operators, and foreign firms be given access rights to an oil pipeline. Also spelled out clearly was the requirement that the price of cooking gas be raised by 80 percent ... what amounted to a massive hit to the household budgets of Ecuador's many very poor citizens." Not surprisingly, Ecuadoreans responded with street riots in February 2001 after the price hike was implemented. Journalist Greg Palast noted in the London Observer that, in all, the IMF's 167 conditions seem "less like an assistance plan and more like a blueprint for a financial coup d'etat."

The following year, 2002, the IMF made the kind of demand that brings tens of thousands of protesters into the streets when the Bretton Woods institutions hold their annual meetings. By Ecuadorean law, the government must dedicate 10 percent of the revenue from oil passing through a new pipeline to health and education. The IMF said this would have to change and the money earmarked for social programs would have to go into paying down Ecuador's public debt, which by now was $16 billion.

The advocacy group Health-Wrights says that:

* The richest 20% of Ecuador's people have 61% of the country's income; the poorest 20% have only 1.5% of the income;

* Half the population lacks adequate access to basic health care and a third lack adequate housing;

* More than 50% of the country's children are malnourished and 80% of the Indigenous People live in poverty;

* Adopting the U.S. dollar did not halt inflation as hoped. It means people must now pay higher prices for basic necessities.

The government of President Noboa broke off talks with the IMF over the tough terms of structural adjustment, but lost the November 2002 election. The new government of Lucio Gutierrez seems more willing to accept the IMF's conditions.

However, without economic reform, many developing country economies, such as Ecuador's, would simply go from bad to very much worse.

Paying back IMF loans can be very hard on the poor people of the developing world. However, if IMF loans are never repaid, rich countries such as Canada would have to repay the debts on their behalf. If the rich, industrialized nations don't top up the IMF's lending account there will be no funds available to help deal with the next debt crisis in the developing world.

Website

International Monetary Fund (Washington Consensus)--http:// www.imf.org/ external/pubs/ft/ seminar/1999/ reforms/Naim.HTM 

Institute for International Economics (Washington Consensus)--http://www.iie. tom/publications/ papers/ williamson 1102.htm

Institute of International Finance--http://www.iif.com/

RELATED ARTICLE: The aid industry.

Lord Peter Bauer was born in Hungary in 1915. As a young man, he moved to England and took up the study of economics, particularly with regard to poverty and development. Opportunities for profit, not government plans, are the key to development he says. He believes that aid directed into the hands of governments has hampered growth and increased corruption. Interest groups, he claims, have spent their time fighting over access to aid money rather than engaging in productive activity. Lord Bauer has written that aid has proved "an excellent method of transferring money from poor people in rich countries to rich people in poor countries." He suggests that rich nations started doling out foreign aid because of guilt over the way they exploited their former colonies. Now, according to Lord Bauer, there is such a huge international development industry that it will keep rolling along "regardless of its effects."

RELATED ARTICLE: Round and round it goes.

Bankers in New York were fiercely opposed to the creation of the International Monetary Fund. Prior to the IMF hanging out its shingle these bankers had a lock on international credit arrangements; they didn't want a competitor driving down their profit margins. However, banks in the U.S. and other developed countries were quick to realize how the IMF could help them. Private banks could lend money in countries with shaky economies with confidence. Because such loans are risky, the banks can charge high rates of interest. But, the banks were unlikely to get stuck with an unpaid loan; the IMF is there to bail out borrowers who can't pay back their loans. The private banks get their money back plus high interest.

In his book Globalization and Its Discontents economist Joseph Stiglitz described how this worked during the Asian financial crisis of 1997-98. He wrote that even as the economies of countries such as Thailand and Hong Kong were going into a free fall, Wall Street bankers were writing up loans. They knew they'd get their money back through the IMF, which was drawing much of its funding from taxpayers in rich countries. So, the banks were using the collapse of Asian economies to gain access to public funds in their own countries.

On the other hand, private investors didn't emerge from the wreckage without a few cuts and bruises. According to the Institute of International Finance, private investors lost some $225 billion during the Asian financial crisis of the late 1990s, and about $100 billion as a result of the 1998 Russian debt default.

RELATED ARTICLE: The Washington consensus.

Consensus is an agreement by all parties concerned with an issue. By that definition, the so-called Washington Consensus is poorly named. It is an informal agreement among the World Bank, the International Monetary Fund, and the United States Treasury Department. Those most affected by its application are not part of the "consensus."

The Washington Consensus was developed to deal with the financial pickles that South American countries got into in the 1980s. Many governments on the sub-continent were running huge budget deficits. Taxes were being used to support horribly inefficient and money-losing government-owned businesses. Tariff walls protected private industries from foreign competition and meant high prices for consumers. Poor government policies resulted in high inflation; in the most extreme cases, such as Argentina, prices were rising by several thousand percent a year.

The Washington Consensus applies a sharp dose of conservative economic discipline. It calls for drastic cuts to government spending, the selling of government-owned businesses to the private sector, and the opening of domestic markets to foreign competition. Former Chief Economist of the World Bank, Joseph Stiglitz says that in dealing with South America's problems, the Washington Consensus "made considerable sense."

RELATED ARTICLE: Capital flows both ways.

Commercial banks around the world argued strongly that they should be able to move their money around as they wished. This meant removing the regulations many countries had about the export of capital. Nations put restrictions on how much money can be taken out in an attempt to stabilize their economies. The commercial banks got what they wanted and the IMF carried their message to developing countries; barriers to the movement of capital started to come down in the 1980s. The IMF argument is that if a state doesn't liberalize its financial controls it will not attract foreign investment. People will simply put their money in places that allow them freer access. As the controls came down, money began to move; big money and big moves. But, a lot of the foreign investment was what economists call "hot money."

Currency traders move huge amounts of money in and out of countries, sometimes by the hour. This is not investment in a country It is the placing of very large bets on whether a currency is going to rise or fall in value. Sometimes, the amount of money on the move at the click of a mouse is so big that it can bring about the rise or fall all on its own.

Jessica Einhorn, a former managing director of the World Bank offers some interesting figures. In the September/October 2001 issue of Foreign Affairs, Ms. Einhorn wrote: "Net private capital inflows to developing countries plummeted by more than half in 1996-98. Even more important, commercial bank lending proved the most volatile, moving from a net inflow of $118 billion in 1996 to an outflow of $45 billion in 1998."