IMF loan programs found to increase domestic income inequality

December 10, 2020
U.S. banks' influence over the IMF leads to high profits. (AP Photo/Jose Luis Magana)

U.S. banks' influence over the IMF leads to high profits. (AP Photo/Jose Luis Magana)

Loan programs administered by the International Monetary Fund increase income inequality in the countries that are recipients of them, according to recent research, a finding that calls the organization’s commitment to goals including sustainable development and poverty reduction into question.

In an article published Dec. 2 in The Review of International Organizations, Valentin Lang, an assistant professor of international political economy and development at the University of Mannheim, analyzed data revealing that IMF loan programs ramp up domestic income inequality, likely by incentivizing national policy shifts that lead to both absolute and relative income losses for poor citizens.

The effect lasts for up to five years, according to Lang’s research, and is stronger for IMF programs operating in democratic states. His findings suggest that the conditions embedded in the loan facilities may distort domestic political processes that could otherwise act as a check on income inequality.

Headquartered in Washington, D.C., the IMF has administered loan programs in over 130 countries since its founding in 1945. The organization often requires that recipient nations agree to spending limits and labor market reforms, which impact the way income is distributed among the populace.

While the IMF can’t coerce recipient nations legally or with military force, asymmetries between the negotiating parties may leave cash-strapped countries with little choice but to accept the terms they’re given.

“These countries become dependent on these loans,” Lang said. “And the IMF says, ‘If you don’t comply [with the conditions], we cannot give you the next tranche.’”

Many states that reject the conditions therefore run the risk of “very large economic shocks,” he added.

Caps on social spending, reductions to the minimum wage and privatization of state-owned enterprises often feature in the IMF’s loan conditions, prompting national policy changes with direct and indirect impacts on individuals’ incomes and broader economic prospects.

In particular, “The fact that the IMF puts these strict limits on public spending translates into cuts in education spending, health spending [and] social spending,” Lang said.

In responding to a number of domestic political and economic pressures on top of the IMF’s loan terms, nations in need of liquidity frequently tighten their belts and liberalize their labor markets in the ways that best accommodate their most powerful constituents at home as well as major economic players abroad.

Recipient governments therefore “cut in sectors where the people who benefit from the spending actually are the least powerful,” said Lang. “They cut where it’s politically most convenient.”

Although the data can’t conclusively prove that the IMF’s loan conditions cause income inequality by short-circuiting domestic democratic processes, Lang said it isn’t a coincidence that this effect is concentrated in democracies rather than in states with other political systems.

“Democracies have some kind of mechanism whereby they protect the poor in normal times,” he said. But there seems to be “some kind of reduction of how democratically a country is governed while the IMF is there” providing liquidity to it.

Lang believes that future research could provide further insights into how the IMF’s governance structure shapes the way it designs its programs. Until then, the evidence suggests that the organization lacks input from many countries that feel the effects of its loan conditions most directly.

“The evidence on IMF decision-making is very strong on who calls the shots,” he said. “It’s clear that it’s the most powerful member countries, it’s clear that it’s mainly the U.S. and European countries.”

These nations “primarily want their money back — and they don’t really care how,” he added. “So they don’t really care about inequality in these countries, and they are the ones who design these programs … directly or indirectly.”

The result, according to Lang, is that, “IMF loan allocation reflects the interests of the most powerful member countries, and also the personal preferences of IMF staff.”

To better represent all of the 190 countries that participate in the organization, Lang said, the IMF will need to lean more heavily into democratic deliberation. By integrating recipient nations into the loan designing process, inviting nongovernmental organizations to the table and further democratizing its voting protocols, the body can address its “democratic deficit” and craft financial assistance programs more closely aligned with its stated goals of sustainable economic growth and poverty reduction.

“We need to find ways we can give parliamentarians or international parliamentary assemblies more access and political power in these [international economic] organizations,” Lang said, noting that national representatives should have a meaningful say in crafting fundamental economic reforms.

The study, titled “The economics of the democratic deficit: The effect of IMF programs on inequality,” was published Dec. 2 in The Review of International Organizations and authored by Valentin Lang, University of Mannheim. 

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