Testimony of Mark Weisbrot
Research Director at the Preamble Center¹ 

Before the General Oversight and Investigations Subcommittee,
House of Representatives
Committee on Banking and Financial Services

September 10, 1998

On the International Monetary Fund and its Operations in Russia

Mr. Chairman and Members of the House Banking Oversight Committee, I would like to thank you for this opportunity to testify regarding the IMF’s intervention in the Russian economy. This hearing comes at a time of severe economic and political crisis in Russia, as well as a regional depression in Asia, and mounting economic stress in Latin America and elsewhere.

At the same time, the United States Congress is being asked to appropriate $18 billion in additional funds to expand the IMF’s capacity to intervene not only in Russia, but in other countries that may find themselves in economic crisis in the near future. It is therefore appropriate to ask whether this institution is capable of contributing to the resolution of such crises, or whether it is likely to make them worse.

In Russia, attention has been focused on the events that triggered the current crisis: the collapse of the ruble and the government’s partial default on its debt.

But there is much more here than meets the eye. While the current crisis is serious, the Russian economy has already collapsed over the last seven years of "reforms." These "reforms" were designed by the IMF and supported by successive administrations of the United States government, none of whom have acknowledged complete failure of their policies.

The IMF has presided over one of the worst economic declines in modern history. Russian output has declined by more than 40% since 1992-- a catastrophe worse than our own Great Depression. Millions of workers are denied wages owed to them, a total of more than $12 billion. Pensions are delayed by at least three to six months.

Most economic transactions now take place through barter. The majority of the population has fallen into poverty. Death rates have risen sharply, and the decline in male life expectancy-- from a pre-reform 65.5 years to 57 years today-- is unprecedented in peacetime, in the absence of a natural disaster. And all of this had occurred before the current meltdown.

These are the results of "shock therapy," a program introduced by the International Monetary Fund in 1992. Things were supposed to get worse for about six months, and then get better. Six years later, Russians have undergone many shocks, but still no therapy.

In retrospect, it's hard to see what could have been done wrong that wasn't. First there was an immediate de-control of prices. Given the monopoly structure of the economy, as well as the large amount of cash savings accumulated by Russian households, inflation soared 520% in the first three months. Millions of people saw their savings and pensions reduced to crumbs.

In order to push inflation down, the authorities slammed on the monetary and fiscal brakes, bringing about a depression. Privatization was carried out in a way that enriched a small class of people, while the average person's income fell by about half within four years.

"Shock therapy" has also created a large and powerful criminal class: Russian police have to wear masks to conceal their identity when arresting organized crime figures. The head of the Russian Interior Ministry’s organized crime division estimated that 20 percent of Russian bank loans were actually payments to organized crime. This is often treated as if it were always a part of Russian life, but in fact there has been an explosion of organized crime in the "reform" era. This is a result not only of the destruction of the economy, but also the rapid privatization, which left organized criminals as one of the few groups of people that could position themselves to buy up formerly publicly-owned assets.

Democracy, too, has been compromised. The unpopularity of these destructive economic policies has fostered increasingly authoritarian practices on the part of Russian President Boris Yeltsin. The Clinton Administration, wedded to these policies, has supported a number of anti-democratic measures, including President Yeltsin's dissolution of the democratically elected Parliament in 1993. 

The IMF’s defenders have yet to admit failure of any kind. On the contrary, the Clinton Administration is insisting that more "disciplined, hard things," need to be done, such as closing down more enterprises, and balancing the central government budget. Never mind that we would not expect to balance our own federal budget during a recession, much less during a depression.

They argue that Russia’s problem is that they did not take enough of their "reform" medicine. But the historical record shows that Russia actually followed their prescription fairly closely, and the direct result is the catastrophe they are facing today.

As noted above, the de-control of prices was immediate, and the IMF did not anticipate the terribleinflation that would result. The resulting inflationary spiral discouraged any long-term investment inproductive activity. The IMF’s insistence on tight monetary policy to bring down inflation accelerated the economy’s collapse. The Fund’s defenders complain of deficit spending by the Russian government, but for the first four years of "shock therapy," the government mostly stayed within the Fund’s target range. As the economic collapsed continued, tax collection became increasingly difficult. A recent survey found 73% of the transactions of major enterprises were carried out through barter, debt swaps, or other non-monetary exchanges. In such situtations it is not that easy to increase cash tax receipts.

Privatization, too, was accomplished very rapidly. By 1994 more than three-quarters of industrial production was taking place in non-state enterprises. The idea was to create efficiently run firms that could compete on world markets, but this did not happen. The Russian economy was highly integrated. It was not that easy to just "weed out" some enterprises so that others might prosper, since they were interdependent. In addition, the necessary capital was not made available for the potentially "efficient" firms to modernize.

The IMF’s idea of "efficiency" is also problematic: from their point of view, if existing production cannot compete in world markets, it is not efficient and should be scrapped. But this does not take into account the enormous waste of resources in allowing tens of billions of dollars of plant and equipment to lay idle and rust-- not to mention the resulting unemployment.

Foreign direct investment was supposed to play a key role in providing capital, but this never materialized, given the instability of the economy. During the first two years of "shock therapy," the outflow of capital exceeded inflow by two to four times. But the whole idea that Russian industry had to be destroyed, so that they could start from scratch on the basis of foreign investment, was wrong from the beginning.

The IMF’s most recent failure in its attempt to support the ruble has been overwhelming. The ruble lost two-thirds of its value against the dollar within days, setting off panic buying and a new round of inflation that may exceed the worst of the "reform" era. Nearly $5 billion, the IMF’s latest installment on a $23 billion package, was squandered-- delivered right into the outstretched hands of speculators-- in a futile attempt to maintain the exchange rate at 6 rubles to the dollar. Before it collapsed, the Russian government was forced to pay 170% interest rates on its short-term debt, while millions of workers went without wages.

In such circumstances, what is the point of maintaining the convertibility of the domestic currency into dollars? The IMF argues that it is essential to creating a climate in which foreign direct investment can be attracted, but that is clearly not worth the price in Russia, where the capital flows that were attracted were overwhelmingly speculative. This is another example of the IMF’s skewed priorities, which have now brought Russia to a state of economic and political chaos.

As the irrationality of subordinating the domestic economies of "emerging market" countries to the whims of international financial markets becomes more apparent, a debate over the current "IMF consensus" has arisen within the economics profession. A number of prominent, pro-globalization, economists have come out in favor of increased capital controls. Joseph Stiglitz, chief economist of the World Bank and former chair of President Clinton’s Council of Economic Advisors, has openly accused the IMF of exacerbating the Asian financial crisis. Columbia University’s Jagdish Bhagwhati, one of the world’s most prominent international economists and the Economic Policy Adviser to the Director-General of the GATT (1991-93) has noted that "the Asian crisis cannot be separated from the excessive borrowings of foreign short-term capital as Asian economies loosened up their capital account controls and enabled their banks and firms to borrow abroad. . . it has become apparent that crises attendant on capital mobility cannot be ignored." Jeffrey Sachs and Steve Radelet of the Harvard Institute of International Development have reached similar conclusions in their extensive research on the Asian financial crisis, and Sachs has had some harsh words for the IMF, calling it "the Typhoid Mary of emerging markets, spreading recessions in country after country." Paul Krugman has proposed a return to restrictions on the convertibility of currencies, a policy that was promptly adopted by Malaysia last week.

Krugman’s policy of foreign exchange controls makes more sense than the enormously high interest rates that countries like Mexico and Brazil are now adopting to stem the capital flight, currency collapse, resultant inflation, and possible economic disaster that has threatened them in the wake of Russia’s meltdown. The irrationality of international financial markets has reached new extremes, as one poor country after another is trampled by the herd behavior of investors who may know nothing more than the fact that other investors might be averse to "emerging markets" after the last disaster.

But the IMF has shown little interest in allowing countries the flexibility to implement capital controls, and is still insisting that Russia restore the full convertibility of the ruble.

Before appropriating more money so that the IMF can provide further "help" for Russia, it is worth considering the Fund’s role in the Asian crisis. In this case the IMF not only precipitated the financial crisis, it also prescribed policies that sent the regional economy into a tailspin. The short-term debt build-up that preceded the financial crisis clearly created the instability that turned the fall of the Thai baht in July of 1997 into a regional financial meltdown. With a high level of short-term international debt, a depreciation of the domestic currency increases the cost of debt service. Everyone needs more domestic currency to get the same amount of dollars for debt service, and the selling of domestic currency to get those dollars (or other "hard" currencies) drives the domestic currency down further. It does not take much to set off a panic, especially if the central bank does not have a high level of foreign currency reserves relative to the short term debt. These reserves shrink further as more and more investors convert their domestic currency and domestic assets into dollars. Foreign lenders refuse to renew the short-term loans, and the downward spiral continues.

The rapid accumulation of short-term debt in Asia was a direct result of the removal of capital controls-- at the insistence of the IMF. For example, South Korean, Thai, and Indonesian banks (as well as non-financial corporations) were allowed, in the last six years, to borrow from international markets with fewer restrictions then ever before.

What was needed at the onset of the crisis was a supply of foreign exchange reserves, to assure investors that they did not have to flee the country today in order to avoid further foreign exchange losses tomorrow. The government of Japan actually proposed, at a meeting of regional finance ministers in September 1997, that an "Asian Monetary Fund" be created in order to provide liquidity to the faltering economies, and with fewer of the conditions imposed by the IMF. This fund was to have been endowed with as much as $100 billion in emergency resources, which would come not only from Japan, but from China, Taiwan, Hong Kong, Singapore, and other countries, all of whom supported the proposal.

After strenuous opposition from the U.S. Treasury Department, which insisted that the IMF must determine the conditions of any bailout before any other funds were committed, the plan was dropped by November. It is impossible to tell how things might have turned out differently, but it is certainly conceivable that not only the depression, but even the worst of the currency collapses could have been avoided if the fund had been assembled and deployed quickly at that time.

The IMF then failed to provide the necessary reserves-- Indonesia had received only $3 billion by March of 1998. Even worse, the IMF’s insistence on very high interest rates, as well as fiscal austerity, worsened the contraction of the injured economies. The result was that a liquidity crisis, which could have been managed and limited to the financial sphere of the economy, became a major regional depression.

The human cost of this depression has been staggering. Years of economic and social progress are being negated, as the unemployed vie for jobs in sweatshops that they would have previously rejected, and the rural poor subsist on leaves, bark, and insects. In Indonesia, the majority of families now have a monthly income less than the amount that they would need to buy a subsistence quantity of rice, and nearly 100 million people-- half the population-- are being pushed below the poverty line. Women have been particularly hard hit: they are first to be laid off, have taken sharper cuts in access to food and other necessities, and girls are being pulled from school to help with their
families’ survival.

It is especially disheartening to read that the IMF’s managing director, Michel Camdessus, has referred to the Asian crisis as "a blessing in disguise."

The IMF’s favorite reformer, Anatoly Chubais, has now admitted that he "conned" the IMF out of $20 billion. But the IMF economists are not the only ones who have been fooled. All the people who thought they would be bailed out by the Fund, but were then thrown overboard, are among the victims. American taxpayers, whose taxes make up the largest contribution to the Fund, have also been deceived as to the nature of this operation.

The IMF has never served as a lender of last resort, as the world had been reminded in the cases of Russia and Indonesia. It is not a rescue mission. Its policies over the last year have failed as spectacularly as can be imagined, and the last seven years of "reform" have left the Russian economy in ruins. Yet there is no sign that the Fund’s managers are aware of their mistakes. Is there any reason to think that they will do better in the future?

1. Mark Weisbrot served as Research Director of the Preamble Center until 1999. He is currently co-director of the Center for Economic and Policy Research (http://www.cepr.net).