Congress will soon have to decide whether to grant an increase in funding for the International Monetary Fund (IMF). In a normal year, most legislators would go along with such a request on grounds that the IMF is an essential financial institution for the world economy. It makes loans to the developing world and aids in restructuring economies that are either in transition toward a market economy or are undergoing a difficult economic downturn.
This, however, is not a normal year. The IMF has just made a possible a $188 billion bailout of failing Asian economies, with its own portion of the bailout totaling $36 billion. It still has an additional $47 billion to spend, but according to the Heritage Foundation, it wants Congress to authorize a $3.4 billion emergency line to credit and $14.5 billion increase in general funds.
Congress would have intervened to stop these bailouts, but the White House already committed money from the Exchange Stabilization Fund without congressional approval – a financial move of dubious constitutional legitimacy. More money to the IMF, many legislators suspect, means more bailouts – and probably increasingly larger ones.
Thus, a fight on IMF aid increases has already broken out, with former Secretary of State George Schultz, former Secretary of Treasury William Simon, and former Citibank chairman Walter Wriston calling for the complete defunding of the IMF.
Who Pays the Piper?
A part of the debate should be a long-overdue discussion of the role of economic responsibility in economic life. Who should be responsible for owning up to financial errors when they occur? Can people justly avoid the consequences of breaking promises? From what level of government should aid be forthcoming and should it be public or private? What kinds of incentives and disincentives are fostered if investments that go belly-up are continually bailed out?
These are questions that Catholic teaching deals with directly in its moral and social doctrine. Before discussing and applying this doctrine, however, we must have a clear understanding of what is behind the economic crisis in the first place. Recessions and devaluations are not acts of nature, such as floods and hurricanes. Clusters of entrepreneurial errors – when banks and businessmen suddenly discover their investments not paying – are usually a consequence of structural defects in the economic system itself.
Indonesia, Malaysia, and Thailand are liberal economies (“market economies,” in Pope John Paul's terms) in many respects. Private property is secure and prices are allowed to float freely – institutions that partially account for their quick rise to prosperity. At the same time, though, structural defects run very deep in these countries. Their governments and banking systems were linked in ways that allow for corrupt relationships to develop with the business sector.
Sometimes these defects and improperly close relationships are referred to as “crony capitalism.” This phrase is potentially misleading. Capitalism is a system whereby profits exist alongside losses as a means of sorting out successful and unsuccessful economic projects. A system that subsidizes profits and prevents loss from afflicting firms and banks with political ties to the government is not crony capitalism. It is better described as sector-specific socialism.
Everyone agrees that these structural defects need to be remedied, but rectifying the problem that initially set off the wild boom-bust cycles in Asia is going to require far more than tinkering around the edges. The central banks of these economies must be reined in so they will no longer pump excess supplies of credit into business ventures that are favorable to government.
When this credit – much of it pyramided on top of central banks' dollar reserves – is initially pumped into the system, it creates the illusion of prosperity. As the investments become unviable and investors start to sell domestic currencies for sounder international ones, however, the currency comes under intense pressure and devaluations are made inevitable.
The result is tremendous human suffering and political instability, suffering that can only be alleviated by a steady process of restabilization and political normalization within the framework of the market economy and sound money.
The principles of this reform strategy are underscored by John Paul II in Centesimus Annus: “Economic activity, especially the activity of the market economy, cannot be conducted in an institutional, juridical, or political vacuum. On the contrary, it presupposes sure guarantees of individual freedom and private property as well as a stable currency and efficient public services.” (48)
What's the Proper Remedy?
How will the IMF aid assist in bringing about the much needed reforms? This case has not been made. On the contrary, bailouts on the level at which the IMF has been pursuing them serve to subsidize and stabilize sectoral socialism, prolonging the readjustment process and virtually insuring that new problems are going to crop up at a later date. In fact, bailouts put the entire financial sector on welfare and thereby foster a dependency relationship between governments and aid institutions.
In fact, the Pope warns specifically against government interventions that are likely to create more problems than they solve.
“Supplementary interventions,” he advises, “must be as brief as possible, so as to avoid removing permanently from society and business systems the functions of which are properly theirs, and so as to avoid enlarging excessively the sphere of state intervention to the detriment of both economic and civil freedom” ( CA 48).
What can be done to restore the proper functioning of business in Asia? In addition to undertaking deep structural reforms that will replace sectoral socialism, those responsible for making economic errors must be responsible for them and not expect others to pick up the tab. Businesses that made bad investments must suffer losses. Banks that made bad investments must consider them losses as well. Of course the process is painful, but the only option is to subsidize errors and therefore create what economists call a “moral hazard” leading to ever more economic crisis.
All investment requires investors to undertake some level of risk. The higher the risk, the higher the returns will be on success but also the probability of failure will be greater. Investors use the information provided by past experience and expectations about the future to judge whether to undertake some risk. All investment involves a two-way promise: profits accrue to those who take the risk but losses to the same if that risk doesn't pan out. Bailouts and subsidies shield investors from the consequences of their actions and make promise-breaking possible.
This is contrary to Catholic ethics. As the Catechism of the Catholic Church states: “ Promises must be kept and contracts strictly observed to the extent that the commitments made in them are morally just. A significant part of economic and social life depends on the honoring of contracts between physical and moral persons – commercial contracts of purchase or sale, rent, or labor contracts. All contracts must be agreed to and executed in good faith.
“Contracts are subject to commutative justice which regulates exchanges between persons in accordance with strict respect for their rights. Commutative justice obliges structure; it requires safeguarding property rights, freely paying debts, and fulfilling obligations freely contracted. Without commutative justice, no other form of justice is possible“ (2410-11).
It is obvious that full-scale socialism violates commutative justice, but so does sectoral socialism. Why should some businessmen have access to the public treasury and others not? Why should some firms gain credit from the central bank when there are insufficient savings in the systems to back up the extension of massive loans? Why should inept managers and go-go investment houses be rewarded for their errors while everyone else, including U.S. taxpayers, are forced to pay the price?
If market economics are pampered with international aid, the structural defects perpetuate and the sectors of socialism only grow larger. Neither do IMF bailouts help people as much as often supposed. In the case of the 1995 Mexican bailout, the people underwent enormous suffering but the government and international bankers did not. Mexico met its debt obligations and investors were paid, but vast numbers in the middle class lost jobs and livelihoods. Much needed reforms never materialized because the system that caused the problem in the first place was left in tact.
A Better Solution
The social instability inevitably created in economic crises must be addressed by local government authorities, civic organizations, communities, and families. The IMF is a poor substitute for these institutions; in fact, outside aid from international organizations can displace these social functions.
Pretending that the IMF is a good substitute for financial honesty and community responsiveness runs contrary to the all-important principle of subsidiarity. As the Pope says, “a community of a higher order should not interfere in the internal life of a community of a lower order, depriving the latter of its functions, but rather should support it in case of need and help to coordinate its activity” ( CA 48).
The relationship between public and private morality is a growing area of public debate. Should the moral standards we associate with good and honest private behavior also be embodied in the principles that animate public policy? Surely so. When we make promises, we must keep them or deal with the consequences. It should be no different with international banking and finance. They must meet the contractual obligations and not turn to world taxpayers for an easy out.
Congress ought to think about the basic moral principles of sound money, promise keeping, and subsidiarity when considering whether to give the IMF ever more tax dollars with which to play. By the fundamental standard of Catholic social teaching and morality, such increases in IMF funding – and indeed the IMF bailout of Asian economics itself – appear contrary to standards of justice and the kind of market economy the Pope has repeatedly embraced in his writings.