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Op-ed

From the Jaws of Defeat

by Simon Johnson, Peterson Institute for International Economics

Op-ed originally posted at TNR.com
March 30, 2009

© New Republic


Even before the G-20 summit begins (with dinner on April Fool's Day), world leaders have decided not to address most of the major questions of the day: how to adjust monetary policy around the world, how to save Europe from itself (difficult but still doable), and how to break the political and economic power of major banks. And, according to the latest background briefing from the White House, the communiqué language that will be used for fiscal stimulus and regulatory reform is likely to be somewhere between meaningless and mush.

Why is the G-20 neglecting fundamentals? We can mainly attribute it to a failure of leadership, particularly at the European level. President Obama has an all-star team of policymakers with international economic experience (there is no shortage of talent due to nomination issues on this dimension), but they came late to the G-20 process, through no fault of their own, and are still scrambling to catch up. The Europeans still control the agenda, and keeping their heads in the sand (and their electorates in ignorance) remains a top priority; otherwise they would need to admit that (a) they were asleep at the wheel early in the crisis, and (b) even now they are woefully unprepared for the effects of the global slowdown on their own economies.

The only potential scope for substantive progress at the G-20 summit, and thus the difference between abject failure and modest success, is the scale of additional support for the International Monetary Fund (IMF; for more background, see the piece I wrote over the weekend). On this relatively straightforward issue, there now appears to be both an impediment to real progress and a great opportunity for the American side.

The technocrats and politicians claim that they're trying to find extra cash to "beef up" the IMF's ability to lend (they're still figuring out how much will be available and on what terms). But it is now becoming increasingly clear that the Europeans are on the verge of keeping the discussion away from the most important constraint on IMF activities: its current lack of experienced people.

The reason for this European reticence is an open secret. In early 2008, as the IMF was warning, politely, but firmly and publicly, that deeper trouble lay ahead in the US and European financial systems, the G-7 pressed for cuts to IMF staff. The key industrial countries, led by a complacent Bush administration, but aided and abetted by the Germans, French, British, and some other Europeans, strongly supported budget cuts of a level and form that forced the exit of around 20 percent of the Fund's staff, including many of the most experienced. Their reasoning was that the IMF was no longer as needed as in the past; the fact that some of those forced out had also been most critical of G-7 policies was a pleasant bonus for Americans and Europeans who wanted to stay in denial about the state of the world economy.

But here's where it gets really frustrating: Even though the crisis has substantially worsened since the spring of last year and the IMF is widely acknowledged, including now by the G-7 and the G-20, to have a key role to play going forward, there has been no serious move to undo the staff cuts. The Fund's staff is clearly stretched to the breaking point. The remaining economists are doing the best they can, and some temps have been brought on board, but in this kind of high-pressure environment, mistakes can be made. The IMF is trying to fundamentally change its engagement with middle-income countries, offering precautionary loans on easy terms for the first time. This involves a whole new approach to both the relevant analytics and diplomacy, delicate tasks that are highly intensive in skilled labor. At the same time, there is what the IMF's managing director refers to as a long line of countries outside his office asking for more traditional crisis loans, all of which call for carefully designed conditionality. The IMF has probably never handled as many complex programs as it probably will over the next six months.

So, with extra funding finally coming the IMF's way, one honest move would be to restore the staff to roughly its previous size and to rehire some key personnel. Given the scale of financial-sector problems around the world, one could make a case for doing more than restoring the Fund's expertise.

The main reason not to do this, though, is that it would implicitly recognize that major IMF shareholders made a mistake in early/mid-2008. Without question, this would be embarrassing, and, understandably, no government that shared responsibility for this ill-timed downsizing is currently comfortable discussing the issue in clear terms.

For President Obama, however, this conspiracy of silence presents a great opportunity. The new US team is not at all implicated in previous IMF staffing policy (this was handled directly by Treasury under Hank Paulson). Secretary Geithner showed leadership when he called for a big increase in IMF funding and activity earlier this month. He and the president should call for the restoration of IMF staff, a renewed focus on financial-sector cleanups around the world, and, more generally, a climate in which it's acceptable to talk about how the global crisis was mishandled during 2008.

It makes no sense to increase the funding available to the IMF without restoring staffing levels back toward (at least) their previous level. Anyone who speaks at or after the summit about strengthening the IMF should be asked point blank: Does it really make sense to downsize the fire department just as it warns that forest fires are starting to spread? And when the fires really take hold, shouldn't every available, qualified person be quickly rehired?

Simon Johnson is a senior fellow at the Peterson Institute for International Economics and a professor at MIT.


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