Friday 17 Aug 2018 | 00:06 | SYDNEY
Friday 17 Aug 2018 | 00:06 | SYDNEY

Want to fix the IMF? Ask an engineer


Stephen Grenville

11 February 2011 11:37

Mark Thirlwell has already noted the surprisingly forthright report of the Independent Evaluation Office on the International Monetary Fund's performance in the lead-up to the Global Financial Crisis.

The IEO has given the IMF a 'fail' mark, with some justification. The Fund missed the warning signs, praised the UK as a model for others to follow, failed to see the sub-prime problems in the US even when others had identified them, and saw nothing wrong in Iceland or Ireland as these fatally over-leveraged countries headed for inevitable disaster.

Behind these specific errors of omission, the problems were more deep-seated. The Fund staff had the wrong analytical model: they are paid-up members of the Efficient Markets fan-club, in favour of light-touch supervision and fervent believers in the market's self-supervising and self-equilibrating capabilities.

The IEO draws on psychology to explain this. The Fund, it says, suffers from group-think and 'intellectual capture' by the academic conventional wisdom. The staff are prone to a version of the Stockholm Syndrome, whereby the Fund's examiners empathise with the national authorities, who have their own powerful reasons for arguing that things are just fine, turning a blind eye to any problems and vociferously denying any deficiencies.

The IEO's report is incisive and insightful in its analysis. But it has little to suggest in terms of meaningful reforms.

It wants the Fund to be 'pro-active in crisis prevention'. The Fund needs to 'clarify the roles and responsibilities of the Board, Management, and senior staff'. It should 'create an environment which encourages candour and diverse/dissenting views'. It must 'speak truth to power'.

The problem, familiar to all regulators, is that they can't respond until the problem gets bad enough to justify action, and by then it is too late. How can they warn of problems without precipitating the crisis and getting blamed for it' The Fund's governance is unreformable; it tries to give a voice to all 187 members but can't reconcile this with the reality that the US (with a veto) and other big members will inevitably dominate the debate and ensure that their interests are paramount.

Big organisations everywhere have trouble promoting dissent, even if they want to. If they 'speak truth to power', they find that power doesn't want to listen. It is simply unrealistic to think that an international agency like the Fund can come out with strong pointed criticism of the principal countries which got into trouble in the GFC – the US and the UK. The Fund might be able to do a frank assessment of an emerging country, but the US didn't even allow the Fund to carry out a Financial Sector Assessment Program, which would have been the first step to identifying problems.

Supposing they identified some problems (as the Fund's Economic Counsellor did in 2005); they would be shouted down and/or ignored. No country likes to be criticised by outsiders, least of all those that can exercise a veto, as the US can. Was it likely that the Fund could mount a serious attack on Wall Street's flawed way of doing business when the lobbying power of financial markets over-rode Washington's views'

Of course the Fund can do better, but it needs to start from a realistic assessment of why these deficiencies occurred, not simply to note the problems and urge the Fund to try harder next time.

Maybe the Fund needs to look outside narrow economics for guidance. It might borrow from engineers, who routinely 'test to destruction' (see video): what size and shape of shock would make a financial system fail'

Aircraft safety investigators are less interested in publishing analysis on how well the plane flies in clear skies, concentrating instead on telling how it will behave when things go seriously wrong. They are less inclined to accept profit-driven excuses for cutting corners and taking risks. They build in redundant capacity to allow for system failure and firewalls to prevent contagion. Then the pilots spend a lot of time practicing disasters in the simulator.

It's hard to see any governance format that can back up the 'ruthless truth-telling' that Keynes called for at the time of the Fund's formation, but some root-and-branch revision would be worth trying. Do away with the super-democratic inclusive (but useless) International Monetary and Finance Committee and put the Fund under the general oversight of the G20. Abolish the 24-member Executive Board and replace this talk-shop with less frequent meeting of senior G20 ministers. This delegates more detailed responsibility to the Fund staff, giving them the direct opportunity to 'speak truth to power' and leaving them with no excuse if they don't.