TWN Info Service on Finance and Development (Feb13/02)
14 February 2013
Third World Network

IMF policies exacerbating crisis in EU, says paper
Published in SUNS #7519 dated 6 February 2013

Geneva, 5 Feb (Kanaga Raja) - An analysis of the International Monetary Fund (IMF) Article IV consultations in the European Union has found that there is "an overwhelming emphasis on fiscal consolidation, reduction of social expenditures, as well as measures that would weaken the bargaining power and income of labour, and make it more difficult for governments to promote growth and employment or reduce poverty and social exclusion."

The analysis, showing "a consistent pattern of recommendations on fiscal policy as well as policies concerning employment and social protections", is in a new paper by the Washington DC-based Center for Economic and Policy Research (CEPR).

The paper, titled "Macroeconomic Policy Advice and the Article IV Consultations: A European Union Case Study", is by Mark Weisbrot, an economist and Co-Director of CEPR, and Helene Jorgensen, a Senior Research Associate also at CEPR.

According to the paper, the findings confirm prior research on IMF Article IV consultations in other countries. That analysis, which looked at 50 Article IV consultations for developing countries, found similar predilections with regard to fiscal consolidation and other "one-size-fits-all" policies that were not necessarily appropriate for these developing countries.

"From these documents, the IMF appears to be pursuing a political and ideological agenda in Europe, with a very strong prejudice toward spending cuts and smaller government," said Weisbrot in a press release. "These are policies that have helped cause the eurozone's second recession in three years, and record levels of unemployment," he added.

According to the paper, Europe remains mired in its second recession in three years, and the IMF's most recent (October 2012) World Economic Outlook (WEO) sees its problems as perhaps the most important drag on world economic growth, which has slowed to a projected 3.3 percent for 2012 (as compared with 3.8 percent for 2011 and 5.1 percent for 2010).

Many economists, including Nobel Laureate Paul Krugman (2012), have argued that the policies implemented by the European authorities have helped push Europe into recession, and/or have been impeding the recovery. The IMF is part of the so-called "Troika" - with the European Commission (EC) and European Central Bank (ECB) - that has been deciding or strongly influencing economic policy in the eurozone, as well as affecting policy in the rest of the European Union, especially since the world economic crisis and recession of 2008-2009.

The paper said that it is therefore worth examining IMF policy recommendations to see whether they have contributed to the ongoing crisis in Europe, and also how they might affect other European Union goals such as those of Europe 2020, which seeks to reduce social exclusion, promote public investment in research and development, and promote employment and education.

Noting that the IMF makes policy recommendations to European countries through its Article IV consultations and resulting papers, the paper explained that the IMF's Article IV consultations provide recommendations on a broad range of issues including fiscal, monetary, and exchange rate policy; health care and pensions; labour market policy (including wages, unemployment compensation, and employment protections); and numerous other policy issues.

The CEPR paper examined the policy advice given by the IMF to European Union countries in 67 Article IV consultations for the four years 2008-2011. It said that it is a follow-up to an International Labour Organisation study on 50 Article IV consultations undertaken for low- and middle-income countries (2012). It focuses in particular on fiscal adjustments, inflation targeting (in countries where it is relevant, i.e. outside the eurozone), employment generation and social protection.

The paper finds a consistent pattern of policy recommendations, which indicates: (1) a macroeconomic policy that focuses on reducing spending and shrinking the size of government, in many cases regardless of whether this is appropriate or necessary, or may even exacerbate an economic downturn; and (2) a focus on other policy issues that would tend to reduce social protections for broad sectors of the population (including public pensions, health care, and employment protections), reduce labour's share of national income, and possibly increase poverty, social exclusion, and economic and social inequality as a result.

The paper further finds that fiscal consolidation is recommended for all 27 EU countries, and expenditure cuts are generally preferred to tax increases. In some cases, there are targets or limits on public debt/GDP ratios or fiscal deficits that are below those of the Maastricht treaty. There is repeated emphasis on cutting public pensions and "increasing the efficiency" of health care expenditures. Raising the retirement age is a standard recommendation, without any correlation to a country's life expectancy.

There also appears to be a predilection for increasing labour supply, irrespective of unemployment or labour force participation rates. This includes such measures as reducing eligibility for disability payments or cutting unemployment compensation, as well as raising the retirement age.

"Labour market policy recommendations are overwhelmingly geared towards measures that would either reduce wages directly or - as in the efforts to increase the labour force - put downward pressure on wages. Such measures include the attenuation of industry-wide bargaining practices, and scaling back employment protections."

The authors said that the paper's findings are also consistent with other evidence of policy mistakes, including that provided by IMF research. On the macro-economic side, the IMF's most recent WEO finds that the IMF (as well as other forecasters) seriously under-estimated government spending multipliers in growth forecasts for countries since the beginning of the Great Recession. Instead of a multiplier of 0.5, they find a range of 0.9 to 1.7.

The paper said that this could explain some of the large gap between the IMF's growth projections and growth outcomes for countries undergoing fiscal consolidation under IMF agreements. For example, in September 2010, the IMF projected GDP growth in Greece of -2.6 percent for 2011 and +1.1 percent for 2012. The actual results were -6.9 percent for 2011 and -6 percent (October WEO projection) for 2012. Similarly, in Latvia, the IMF projected, in January of 2009, -5 percent growth for 2009; the actual decline was 18 percent.

The paper noted that a 2009 examination of IMF agreements and reviews made during the Great Recession, with 41 borrowing countries, found that 31 recommended pro-cyclical fiscal or monetary policies, or (in 15 cases) both. These were policies that could be expected to exacerbate a significant slowdown or recession. In that study, there were many cases in which the IMF's pro-cyclical policies were based on overly-optimistic assumptions about economic growth.

Pro-cyclical fiscal policies have also played a major role in the deep recessions experienced by Spain, Italy, Portugal, and Ireland, the paper underscored, adding that the IMF's role, together with the European authorities, in promoting these policies, is only partially reflected in the Article IV papers reviewed (in the paper). "But the ‘one-size fits all' policy of fiscal consolidation that is evident in these Article IV consultations is consistent with what the IMF recommended in borrowing countries in the eurozone."

Over the past two and a half years, said the paper, as the crisis in the eurozone has unfolded, the European authorities have repeatedly intervened - even including ECB interventions or pledges to intervene in sovereign bond markets - in order to stabilise financial markets and prevent the crisis from worsening at various times, even while promoting pro-cyclical policies that have prolonged recession. However, there have been numerous press reports indicating that these authorities, including the ECB, were unwilling to take further measures to end the crisis because of a fear that doing so would remove the pressure on eurozone governments to make certain reforms.

"It is possible that the current recession and recurring crises in Europe are a result of this attempt to implement unpopular reforms in various countries - especially since the ECB has several times shown that it can easily limit, and lower interest rates on the sovereign bonds of Italy and Spain when it wants to do so."

In its comparative overview, the paper underlined that its content analysis examined the fiscal policy recommendations offered in IMF Article IV consultations from 2008 to 2011. The IMF consultations provided both short-term economic advice addressing the immediate economic crisis as well as medium to long-term advice for fiscal adjustment, with the content analysis focusing primarily on the medium-term recommendations.

In a number of consultations, said the paper, IMF staff argued that the economic crisis provided an opportunity for economic reforms. For example, in the 2009 consultation report with France, IMF staff wrote that "historical experience indicates that successful fiscal consolidations were often launched in the midst of economic downturns or the early stages of recovery".

In other country cases, IMF staff made the case that the economic crisis created a necessity for fiscal consolidation. For example, the 2010 consultation with the Czech Republic stated "the crisis has highlighted the urgency of fiscal adjustment". Only a few consultations directly discussed the contractionary effects of proposed fiscal consolidation.

The IMF consultations advised fiscal consolidation for each of the 27 EU countries. The consultations generally emphasised expenditure cuts over revenue increases. An expenditure ceiling was proposed for some countries to rein in government spending. For example, in the 2010 consultation with the Republic of Ireland, IMF staff noted that "a medium-term fiscal framework incorporating expenditure ceilings is a valuable management tool".

Most consultations provided specific recommendations on expenditure reductions, and in nearly all cases included reduction in social programs. Other areas frequently identified for consolidation were the slowing of wage growth in the public sector, public sector wage ceilings, reducing public sector employment, and reorganising public institutions.

The most commonly recommended measures to rein in expenditures related to pensions. The IMF recommended reduction in pension spending from current level or projected level in consultations with 81.5 percent of countries. On the other hand, revenue increases were recommended in 70.4 percent of countries. In two-thirds of the countries in which revenue increases were recommended, the IMF also recommended revenue decreases. The IMF did not provide recommendations on government revenue in consultations with 25.9 percent of the countries.

According to the paper, the IMF consultations identified various areas for revenue increases including taxes, deductions, and social security contributions. Tax policy recommendations were country-specific and often included a mixture of increases and reductions in taxes. For example, the 2008 consultation with Hungary proposed "shift in the tax burden away from labour and to consumption and wealth".

Based on the information provided in the consultation reports, the net revenue effect could not be determined in most consultations. Tax areas identified for revenue enhancement included income taxes, property taxes, inheritance taxes, value added tax (VAT), reducing or phasing out the mortgage interest deduction, and phasing out other deductions, exemptions and loopholes.

In a number of consultations, specific budget deficit or debt targets were identified. In some cases, the IMF staff recommended stricter targets than the ceilings set by the Stability and Growth Pact. For example, the 2011 consultation with Hungary stated "the constitutional mandate to maintain public debt below 50 percent is commendable".

In a few consultations reviewed, concerns were expressed about planned fiscal consolidation. The consultation with Poland warned that "aiming at a deficit of 3 percent already by 2012 is too ambitious". While the 2011 consultation with the Netherlands supported the authorities' planning consolidation but cautioned that "historical experience indicates that negative effects on demand from budget consolidation are likely to be higher when monetary policy is not able to accommodate tightening, as is currently the case".

The majority of the consultations reviewed addressed labour market policies. The content analysis uncovered five main areas of labour market recommendations: Wages, employment protection and flexibility, collective bargaining, work incentives, and vocational training.

The CEPR paper noted that during the period of this study, unemployment rose in the EU countries as the recession took hold. Some countries were impacted more than others due to the severity of the recession and their specific labour market structure. By 2010, the unemployment rate ranged from 4.4 percent in Austria to 20.1 percent in Spain.

For the majority countries, the IMF provided recommendations on wage growth, and the advice overwhelmingly favoured wage moderation (18 out of 19 countries). The IMF provided advice on labour supply and/or labour force participation with 48.1 percent of countries. In every case, the advice promoted policies for increasing labour supply. Finally, the IMF recommended scaling back employment protections in 14 out of 14 countries receiving advice on employment protection.

In consultations with seven countries, advice on vocational training and apprenticeship programs supplemented recommendations on weaker employment protection. Increases in labour market flexibility through scaling back of employment protection, decentralising collective bargaining, flexibility in overtime and work-week hours were mentioned in consultations with 15 countries.

To increase employment, IMF consultations for 18 countries advised reducing nominal or real wage growth. Specific recommendations included reducing or eliminating cost of living adjustments (COLA) (for example, Cyprus 2009), wage modification in collective bargaining (Sweden 2011), minimum wage moderation (France 2009), and containing public sector wage growth.

According to the paper, the labour force participation rate varied widely across EU countries, with Malta (60.3%), Italy (62.2%) and Hungary (62.4%) having the lowest rates and Denmark having the highest rate (79.4 percent). Twenty-two consultations with 13 countries recommended increasing labour force participation/labour supply.

"Interestingly, there was no apparent correlation between a country's labour force participation rate and recommendation to increase the labour force. Bulgaria and Malta had some of the lowest labour force participation rates in EU, but the IMF did not provide specific advice on increasing the labour supply in the consultations reviewed. At the same time, the IMF recommended increases in labour supply for Austria, Denmark, Germany, and the Netherlands, countries which had some of the highest labour force participation rates. Likewise, recommendations to increase labour force participation were not obviously correlated with the countries' unemployment rates either."

The consultations provided few specific recommendations on education. When recommendations were made, they were often brief and generic in nature, such as "improve quality of education" (Bulgaria 2010, Czech Republic 2010, Italy 2011, Latvia 2010).

The content analysis identified seven country-specific recommendations on primary, secondary and higher education in seven consultations with seven countries. Some of the recommendations focused on investment in education to increase human capital. Other recommendations were geared toward reducing expenditures.

Many EU countries experienced high unemployment during the period of study, and vocational training and apprenticeship training programs were proposed in consultations with ten countries to reduce mismatches in the labour market. In several cases, vocational training was advocated in combination with increased flexibility. For example, the 2011 consultation with Slovakia mentioned "sharpening the orientation of education and vocational programs towards labour market needs," while at the same time promoting labour market flexibility to maintain competitiveness.

The paper noted that EU countries have some of the highest life expectancies in the world. It said that long life expectancies combined with low birth rates have resulted in an "aging of population" in EU countries, adding that the aging population was a recurrent theme in the IMF consultations with EU countries. Most consultations reviewed explicitly addressed the economic ramifications from an aging population in terms of pension and health care expenditures.

The IMF offered advice on pensions for 22 out of 27 countries reviewed. Pension recommendations were frequently referenced in the context of fiscal consolidation and focused on reducing pension spending in every single case. For example, the 2010 consultation report with Poland noted that "the substantial fiscal adjustment needed over the medium term will require changes in entitlement programs". The 2009 Austrian consultation identified "key areas for consolidation to include... pensions, and education and health".

"Without exception, the pension recommendations focused on scaling back programs by tightening eligibility, raising retirement ages, increasing service period, reducing benefits levels (often through tightening pension indexation), and phasing out early retirement programs. Several consultations advocated expansion of private pensions to supplement cuts in public pension."

Interestingly, the paper stressed, there did not appear to be a correlation between life expectancy and recommendations to scale back pension programs. The Republic of Ireland and Sweden had some of the highest life expectancies, but reviewed consultations did not provide recommendations on increasing retirement age. On the other hand, consultations with Hungary and Lithuania, countries with some of the lowest life expectancies at birth, recommended increasing the retirement age and/or reducing benefit levels.

A total of 26 consultations for 15 countries explicitly mentioned health care policies. As in the case of pensions, health care policy advice was frequently framed in terms of budget consolidation. For instance, the 2008 consultation with Germany warned of "the risks associated with healthcare costs due to an aging population".

Generally, the health care policy recommendations were generic in nature, such as "continued efficiency gains... in health and long-term care spending" (France 2011); "the large efficiency gains that are possible in the health care sector should be promptly reaped" (Austria 2011); and "a comprehensive health care reform, with the view to improve the efficiency and quality of the health care system is needed" (Bulgaria 2010).

Social policy recommendations included both recommendations for expansion of social programs as well as shrinking programs. The IMF consultations provided few recommendations on alleviating poverty and increasing the standards of living through social programs. Most welfare policy recommendations were centered on cutting expenditures.

Recommendations on unemployment benefits focused on reducing level and duration of benefits in order to strengthen job search incentives, reduce public expenditures and increase labour supply. The consultations rarely addressed poverty directly, though some consultations suggested that authorities better target programs to vulnerable populations as the expenditures are being reduced.

According to the paper, the IMF Article IV consultations underestimated the severity of the recession in consultations with a number of countries. In the 2009 consultation with Greece, IMF staff predicted that "Greece's growth decline from peak to trough would still be milder than for the euro-area as a whole". Moreover, "staff projects some recovery in the late 2010". In fact, real GDP declined by 6.9 percent in 2011, and was projected to decline by an additional 6.0 percent in 2012.

"The unanticipated severity and duration of the economic downturn means that a number of IMF country consultations conducted in 2008 and 2009 did not modify advice to reflect actual economic circumstances."

Overall, it added, "there was no discernible change in medium and longer-term recommendations in the four policy areas of fiscal adjustment, inflation targeting, labour market policies and social policies identified in the content analysis."

The review of Article IV consultations also supports the view that policy mistakes by the European authorities - including here the IMF's overwhelming priority of fiscal consolidation - have unnecessarily prolonged and deepened the crisis in Europe, and contributed to a reform agenda that worsens the impact of the crisis on vulnerable parts of the population.

According to the authors, the content analysis in their paper suggests that the IMF might wish to engage in an Independent Evaluation Office review of its policy advice in Europe, similar to its review of the IMF's surveillance in the run-up to the Great Recession and its review of the IMF's policies during the Asian economic crisis of the late 1990's.

"Both of these reports found serious mistakes and led to significant changes in both research and policy at the IMF. Given the urgency of the present situation in Europe, an expedited review of current policy might enable the IMF to play a constructive role in Europe's recovery."

"The IMF is of course the junior partner in the troika, with the European Commission and European Central Bank calling the shots," said CEPR Co-Director Weisbrot. "But they are still an important influence, and these consultations show that their influence, together with their partners, has been unnecessarily harmful for the people of Europe, who are struggling with unemployment and recession."

"As weak as the US economy is, we are very fortunate that our government has not implemented the kinds of policies that we have seen in Europe since 2008," he added.