The IMF and Fragile States

In light of my earlier work on Bosnia, I was recently summoned by the IMF's Independent Evaluation Office to discuss "Lessons for IMF work on Fragile States", as input into their forthcoming study and IMF Board Paper on that topic.

With Syria looming, the topic could hardly be more urgent.

They sent their issues paper and a list of questions in advance, both of which were an "any-related-topic-we-can-brain-storm" scatter. So I disregarded them and focussed on the key issues—that they had not even mentioned.

Before the Fact

First, the nomenclature itself is utterly inappropriate. They are not "Fragile States"; they are "Destroyed States". And they are not self-destroyed; they are destroyed by other States. The largest IMF Board members, eager to pose as "saviors earnestly bringing balm to their "fragile" counterparts", are, in fact, the prime destroyers.

Take Bosnia. It was/is not a Fragile State: it is shrapnel from the destruction of Yugoslavia. The key step in that destruction was German encouragement of Slovenian and Croatian secession in 1990-91, fatally undermining Yugoslav union.

Upto then, Yugoslavia had been a highly integrated, multi-religious, multi-cultural, mono-lingual, semi-federalized State, with grand international trappings—1991 European Cup Winners Red Star Belgrade, the 1984 Winter Olympics, leadership of the Non- Aligned Movement—and a high degree of Yugoslav-conciousness, bumping and scraping along, even a decade after Tito.

But at that point, the outside world failed to distinguish, conceptually, between, on the one hand, the expulsion of forces of occupation to restore settled boundaries (World War II, 1989-90 Eastern Europe and East Germany) and, on the other hand, the destruction of a domestic settlement that would undo such boundaries.

In particular, German enticement—with broader European indulgence—of the Slovenian and Croatian cards from out of the Yugoslav deck, in an echo of World War II alliances, inevitably provoked defensive nationalist sentiment on the part of others, culminating in hand-to-hand slaughter of next door neighbor by immediate next door neighbor, literally, and, ultimately, in the Bosnian "Fragile State".

Iraq 2003 reflected the same—albeit more contested at the time—conceptual failure by inviting Iranian intervention into the subsequent vacuum, with the same catastrophic upshot.

In this general context, a high premium is put on narratives which cast Milosevic, Karadzik, Tuđman, Saddam, Assad and their ilk—awful all—as "The Bad Guys".

But, especially in the memoirs of great power officials involved, the prior role of the international community in creating them is, almost invariably, overlooked.

And the IEO is inclined to do likewise: safer to conceive the issue merely as what the IMF can do "after the fact", casting that as the appropriately "adult" stance for it to take on the matter.

But this will not do.

The lesson the IEO should draw is that once such destruction has been wrought and peacekeepers installed, there are no "econo-technical" fixes: it is never, thereafter, a question of tweaks to a monetary regime or a financial supervisory structure, or to a federal setup or a customs administration, or to the acquisition of "track-record" and business confidence, or to the size, timing, and staffing of IMF assistance: it is chaos.

Even in Iraq, no amount of feasible "should-have-prepared-more-for-post-Saddam" would have made the difference, given the underlying conceptual error—failure to distinguish between expulsion of occupying forces that restores settled borders, versus destruction of a domestic settlement that undoes them.

And history loudly underscores that lesson. That European destruction in Africa dates back to the colonial era only underscores that failure to respect this distinction has very long tails, upto and including the Rwandan and Sudanese disasters.

That point is even mirrored in Syria—the only place, with all due respect to Libya, where the Arab Spring was followed by cataclysm—reflecting its direct connection to Iraq 2003. Such State Destruction has extraordinarily long enveloping tails, with venemous stings.

In this light, the true locus of "fragility" lies not in the destroyed States but in the conduct of the international "community"—the biggest States—which destroy them.

And this "international fragility" is no relic left behind in the dark ages. The corridors of global power, the airwaves, and twitter all still teem with folk who are all-too- ready to call for such destruction, even now, as on Syria.

Nor are these issues above the IMF/IEO mandate or pay grade. In recent decades, its mandate has become infinitely elastic, and if the IMF knew how to patch such things up with econo-fixes, then the message to its princpal shareholders should be "yes we can clean up after you."

But as this is emphatically not so, the IEO has no business hiding behind the skirts of Barack Obama's "Don't Do Stupid Shit" and Colin Powell's Pottery Barn rule "You break it; you own it"—by simply ignoring everything "before the fact".

If it does, it will simply conclude, platitudinously, that "everyone is trying, its case- by-case, and maybe one could tweak this or that but one cannot hope for much."

Instead, the IEO should call on the IMF, emphatically, to add its voice to those of these adults by concluding, on the basis of its ex-post review of the disasters thereby created, that the central message on Fragile States is: "Do Not Destroy".

Peace Negotiations

Second, the IEO cannot—as by default the issues paper proposes—avoid discussion of the conduct of peace negotiations.

It may demur saying that the premium, at such points, is to stop bullets flying, and that the IMF should not in any way complicate such matters any further. Foreign policy officials globally would likely heartily endorse that sentiment.

But, as Bosnia demonstrates sharply, that notion is flat wrong.

The Dayton Peace Settlement established a macroeconomic monstrosity:

  • three interwoven open-bordered regions (see map) were given complete discretion over indirect tax rates, bases, and administration, establishing tax competition between them liable, at any time and without notice, to collapse consolidated revenue;
  • the central government was given no independent source of revenue, leaving it hostage to annual discretionary block grants from lower tiers;
  • all three primary tiers of government had unfettered right to borrow from whomever and on whatever terms and amounts they chose, without reference to one another;
  • within the single currency area, the rules and conduct of bank and non-bank supervision were devolved to tiers below central government, producing race-to- the-bottom competition in those spheres also;
  • though sweeping veto and dismissal powers were given to an internationally appointed "High Representative", those powers expressly excluded intrusion into such Dayton-settled constitutional matters;
  • this mayhem constituted the "backstop" for a currency board;
  • and thus Dayton's macro incoherence was on a par with that of the Euro—the two designs closely resembling each other, for much the same political reasons.

In my time on Bosnia, there were, at any given point, 14 substantive Ministers of Finance, all representing different parties and places, all turning over two-a-penny, all befuddled by the incoherence they were required to operate jointly. As an African senior IMF Manager to whom I once described this setup put it: "It cannot work!"

IBRD folk reassured that they’d help with reconstruction and US Treasury officials reassured that currency board mechanics really were elementary. But no senior macroeconomists were brought into the heart of the peace negotiations in that aircraft hanger in Dayton. Richard Holbrooke and his team there had many strengths, but they had no-one to point out to them that the macro structure they were signing up for was so primed to explode, nor that even just some—let alone exactly which—adjustments could improve prospects significantly.

That is absolutely not to say that IMF economists, chosen by default, should be invited to such negotiations. Most staff would, in such circumstances, only confirm the worst prejudices of the foreign policy officials involved—by emphasizing "first- best", obsequiesly accommodating the preferences of "the authorities" however inconsistent or malign, and compulsively referring back to head-office at every turn.

Instead, a very few highly-experienced staff from the IMF's Fiscal Affairs Department, notably those specialized in fiscal federalism and tax policy and administration, have the necessary expertise and battle-hardened heads to make an effective contribution in such heated and mercurial circumstances.

That said, not even their best macroeconomic counsel at such peace conferences will suffice to put Humpty back together again; the "Do Not Destroy" mantra remains.

Nevertheless, the IEO should call loudly for such expertise to be invited and given a hearing at such peace conferences, well before matters get set, as a matter of routine. This would be in hope of avoiding at least the worst macro incoherences that such middle-of-the-night peace-making by foreign policy officials can—left to their (perhaps?) well-intentioned but macroeconomically illiterate devices—devise.

Their counterparts may not have listened to Keynes at the Conference of Versailles in 1919, but at least they brought him along.

Domestic Debt

Third, debt restructuring is often essential as Fragile/Destroyed States have typically accumulated unsustainable debt burdens during prior conflicts and their productive capacity has been greatly impaired.

Standard procedures, with all their shortcomings, usually suffice to handle external debt in such cases, and Bosnia duly received that assistance.

But external debt may be considerably less than half the problem. Because even if part of domestic debt is inflated away during prior conflict, it can still cripple.

Yugoslavia had inculcated indexation and foreign currency denomination of debt, so inflation mid-conflict provided little relief to domestic debt burdens.

Furthermore, the Bosnian legal system, anxious to reestablish "rule of law" after the civil war lawlessness, enforced what turned out to be a crushing burden of claims on governments for all forms of conflict-related damages (including loss of kin in the various armies), also indexed, as well as arrears of social benefits.

Alongside, most corporations also labored under exorbitant wage and suppliers' arrears, also indexed, on a scale which totally overwhelmed the capacity of corporate bankruptcy procedures to resolve on a case-by-case basis.

Bosnia had little hope of thriving economically with insolvent governments and an insolvent corporate sector, regardless of the incoherence of rest of the macro setup.

And despite herculean efforts, the supreme court flatly rejected any notion of writing down any of these claims "on our war-heroes and our war-victims". It remains unclear—pending possible cases arising from Greece—if any such domestic restructuring would survive a challenge in the European Court of Human Rights.

The only place where such an insolvency time-bomb under any peace settlement can be cleared away is at the peace negotiations, where the legal status of such domestic claims can be determined in the agreed constitution.

To put it plainly, all such domestic claims accumulated during conflict should be given no legal standing. This arrangement should supersede any other arrangements by which the legal system carries over from the pre-conflict system.

And because the extent and nature of such claims may only emerge long after the peace conference, these constitutional arrangements should be put in place there, regardless of what is known about the outstanding debt claims at the time. At most, only claims originated pre-conflict should be recognized. If productive capacity has been significantly impaired by conflict, even those may prove unsustainable.

If governments and corporations are able, after peace, to provide relief and compensation to those damaged in the conflict or to those who have accumulated claims in various forms, that should be provided only as part of ongoing government expenditure or current corporate expenses, not as fulfillment of debt obligations.

This—implicitly a comprehensive debt-for-equity-for-peace swap—ties relief directly to payment capacity ex-post, whatever that turns out to be.

This step may render banks—via their negated claims on corporates and governments—insolvent. Their recapitalization should be directly addressed in the package of external debt relief that is provided.

Absent this determination on domestic debts in the constitution, there is simply no way the legal system can arrange this economic necessity ex-post. If indexation is pervasive, hyperinflation won't do it either. And even if indexation is not present, it is still far better for the nascent "Fragile/Destroyed State" not to have to start out on its shaky odessey with a bout of hyperinflation to address a domestic debt overhang.

Unlike the resolution of external debt, this issue cannot be left "until later."

But even if it is addressed in the peace settlement, it is still no magic bullet; the "Do Not Destroy" mantra remains.

Seal of Approval

Fourth, the IMF, ever keen to be "busy/helpful", strongly inclines to endorse policy arrangements in "fragile/destroyed States" at the earliest opportunity by means of formal IMF programs.

The IEO should strongly challenge that inclination.

The conflicts that yield a deal as incoherent as described in the list of Bosnia bullets above don't just vanish with "peace": they lurk barely an inch below the surface.

So, the IEO should ask, in such a context, how is "sustainability", in the sense applied to other economies seeking IMF program assistance, secured?

The answer is: it isn't.

So when the IMF approves a program in such a context, it is corroding its own brand, a brand whose integrity is badly needed elsewhere in the world.

And these fragile/destroyed State cases are virtually defined by circumstances inimical to such IMF-standards of sustainability:

  • exceptional need for structural reform is set against limited implementation capacity, both deeply contradicting IMF emphasis on parsimony in conditionality;
  • military issues—demobilization etc—are central both fiscally and for stability, but the IMF seeks, at almost all costs, to stay out of military matters;
  • broader international "supervision", including peacekeeping, is chaotic at best, deeply compromising local governance and ownership, both key IMF standards;
  • and international "supervisors" are unconstrained in piling on additional requirements as they proceed: pursuit of their competing national commercial interests using their supervisory sway; voluminous box-ticking for EU aspirants; insistence on purist "democratic" forms regardless of the hostility of the terrain; no prospect—as before and during prior conflict—of even-handedness between the protagonists; and all entirely macro-economically uninformed.

In this overall context, the standard IMF impulse "to do whatever it can to help" and to measure its contribution "at the margin" is deeply counter-productive. By preferring "purist-sounding" requirements that make little sense in the adverse circumstances, it aggravates those locally and internationally who are desperately trying to rescue a disaster; but as attempts are made to adjust those requirements to "reality on the ground", the IMF brand is itself directly compromised.

To resolve this conundrum, the IEO should suggest that the IMF could better serve the world and the cause of peace in such cases by insisting on its standards—by staying out.

This would give such "Fragile/Destroyed States" an ultimate goal towards which to work, namely eventual "graduation" from the immediate exceptional assistance provided by others—perhaps led on the economic side by the World Bank with IMF technical assistance as appropriate. Thus, they would aspire to assistance formally endorsed by a standard IMF program on the same basis as anyone else.

Lest there be misunderstanding, this proposal is no insistence on a purist IMF abstraction in a murky world. Greece demonstrates all-too-vividly what "do what we can to help" means when the IMF fails to insist on sustainability. And if it cannot say "no" in the circumstances that prevail in these "Fragile/Destroyed State" cases, how is it ever going to say "no" in cases such as Greece, or 1990s Argentina, or Ukraine?

And, by staying out, the IMF would underscore, in this context, both that grants are the primary appropriate form of assistance, and the "Do Not Destroy" mantra.

Is the Evaluation Office Independent?

If, having considered all of this you now glance back at the issues paper, you will see none of these matters—central as they obviously are—raised.

In that, it is evident that while independent of the IMF Staff and Management, the IEO is far from independent of the IMF Board. These Fragile/Destroyed State issues—even down to the nomenclature—are raised in a way calculated to rock no boats. And the upshot is that critical shortcomings in Board—as opposed to Management or Staff—behavior go unremarked.

With that, the catastrophes of "Fragile/Destroyed States" go on and on.

Furthermore, do not imagine that Bosnia, by holding together for as long as it has, suggests that these issues "aren't so bad, really": time without disaster says nothing about the threat of accidents-waiting-to-happen (the Titanic would not have been any safer had it sailed half a century without incident); and, though I seldom agree with Mr. Junker, it was no idle exaggeration—given Germany's actions in 1990-91 —when he said, recently:

“If we leave them alone—Bosnia-Herzegovina, Republika Srpska, Macedonia, Albania, all those countries— we will have war again."

The degree to which the final IEO report on IMF work in Fragile/Destroyed States goes beyond plaintive platitudes will be a critical indicator of its independence under its newly-appointed leadership—a career IMF-staffer and, thus, the ultimate "one- of-us" auditor. When it comes, the report should be read in that light.

And with Syria looming, this is no time for him or the IEO to shrink into supine diplomatic convenience.

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