OPINION: IMF and WB conditionalities, and domestic policy—III

While Pakistan has been following structural adjustment policies under IMF programmes quite frequently since around the last four decades, economic outcomes have been less than satisfactory, to say the least.

In his (2016) ‘Springer’ published book ‘The economic impact of International Monetary Fund programmes: institutional quality, macroeconomic stabilization and economic growth’ the author of this article while reflecting on the report of ‘Independent Evaluation Office’ (IEO) of IMF indicated: ‘IEO (2002, p. 119) pointed out that Pakistan’s yearly economic growth was on average around 6–7 percent during the 1970s to the later part of 1980s, and the country was able to sustain its deficits in the fiscal and external sectors, without needing any major foreign assistance.

This situation changed during late 1980s when economic growth started to deteriorate and inability to deal successfully with deficits led to build up of debt. Hence, the country entered successive IMF programmes in the years to follow, starting around the later part of 1980s.

Looking back, the experience proved to be worse in terms of yearly economic growth during 1988–2000, which on average stood at around a little less than 4 %,while at the same time major macroeconomic indicators, for example, inflation rate, foreign direct investment, export growth, and import cover in terms of foreign exchange reserves, all slacked when compared to the earlier two decades (IEO2002, pp. 119–121). Since 2000, the situation has not changed much in terms of sustained macroeconomic stability and economic growth, although Pakistan continues to rely on IMF resources (with only an absence of few years during mid2000s).’

READ MORE: OPINION: IMF and WB conditionalities, and domestic policy—II

As indicated in the previous part of the article series, structural adjustment programmes underlying firstly IMF, and then later on World Bank were fundamentally based on two models – the ‘Polak model’ and the ‘Swan-Salter model’ – developed during the 1950s, both of which were influenced by neoclassical economics.

Hence, since the very start of their existence both IMF, and World Bank have strangely persisted with these two models as the main basis for their lending decisions, even as these programmes performed well below satisfaction. In doing so, it is clear that neoclassical economics – and by extension related fields to neoclassical economics in the shape of monetarist school of economic thought, and neoliberal-, austerity based economic policies – remained the main lens of both Bretton Woods institutions in forming their lending process, and formulating programme conditionalities; while strangely other schools of economic thought like Original Institutional Economics (OIE), Keynesian economics, social democratic policies, or ‘New Deal’ policies were strangely ignored.

Renowned economist, Clara E. Mattei in her (2022) book ‘The capital order: how economists invented austerity and paved the way to Fascism’ indicated that austerity policies were followed by design to preserve the ‘capital order’.

Structural adjustment programmes underlying firstly IMF, and then later on World Bank were fundamentally based on two models – the ‘Polak model’ and the ‘Swan-Salter model’ – developed during the 1950s, both of which were influenced by neoclassical economics.

The book pointed out in this regard the following: ‘While austerity policies may not be identified by name, they underscore the most common tropes of contemporary politics: budget cuts (especially in welfare expenditures such as public education, health care, housing, and unemployment benefits), regressive taxation, deflation, privatization, wage repression, and employment deregulation.

Taken together, this suite of policies [the ‘capital order’] entrenches existing wealth and the primacy of the private sector…Some economists have referred to austerity as a simple “policy mistake”, a technical miscalibration that produced suppression of domestic demand and tightening of labor markets.

READ MORE: OPINION: IMF and WB conditionalities, and domestic policy– I

This viewpoint dramatically underestimates the impacts of austerity… After all, the combination of fiscal, monetary, and industrial policies in the austerity playbook have dealt a lasting blow to the working classes and their expectations for a different socioeconomic system.’

Although the intention of the author is not to question the motivation of the staff of IMF and World Bank, but the argument above does raise question over the motivation of member countries overall of the Bretton Woods institutions, with likely more pressure coming from the considerable influence of rich, advanced countries – most of which increasingly employed the neoliberal- and austerity-based model in their domestic economic policies as well, especially after the breakdown of the Bretton Woods system – in pushing for sticking with neoclassical, and related fields of economics.

Discussing the two models, and their underlying assumptions, the (2008) book ‘Beyond World Bank agenda: an institutional approach to development’ pointed out: ‘The theoretical underpinnings of structural adjustment were, at least in part, products of historical context.

Structural adjustment rests on a theoretical foundation inherited from the Bretton Woods period: that of the stabilization policies of International Monetary Fund. Two key models created the base of these policies: the Polak model and the Swan-Salter model.’

In any case, even as a chance event, the two models, and their assumptions appear highly illogical, where with regard to the ‘Polak model’, the author of this article in his same book indicated that ‘As perthis model, imbalance in balance of payments results from excessive creation ofdomestic credit over money (supply or) demand (usually resulting as a consequenceof excessive financing of budget deficit). …IMF programmes, which are basically built on Polak model (Polak 1957), primarily try to fix Balance of Payments imbalances (and indirectly the fiscalimbalance of the government) by targeting monetary aggregates. But here too critics, including Killick (1995, p. 133), indicate that by focusing too much onmonetary aggregates targeting, programmes are more tilted on the quantitative aspects and do not pay much attention to the qualitative basis of the reform agenda.’

That ‘qualitative reforms agenda’ perhaps is the lack of real-world connection of the model, given its too much reliance on monetarist thought process, especially in the case of developing countries, which have mostly been the client of IMF programmes. Not only that the ‘Polak model’ was for a world of fixed exchange rate, but it continued even after the collapse in 1973 of the Bretton Woods system and, in turn, the end of the fixed exchange rate regime.

Moreover, by being too much influenced by the monetarist school of thought, it sees a very limited role of government, something which is contrary to the ground realities in developing countries due to serious underlying imperfections in markets, and the affairs of the largely translucent, highly hierarchical natured firms/organization with little democratic culture; hence, both require strong involvement of government to reach better product- and labour pricing, and in ensuring a suitable level of workers’ welfare.

The book pointed out with regard to the limitations of the ‘Polak model’, which is also the ‘financial programming model’ of the IMF, and forms the theoretical core for its lending decisions, as follows: ‘The Polak model relies on a monetarist formulation to tie credit growth to the balance of payments. Like the monetarist, it assumes full employment of resources, including labor. There are two key parts to the model: money supply and a fixed exchange rate.’ This is in stark contrast to ground realities, especially in developing countries, where balance of payments does not just get influenced by the change in money supply but also ‘how’ that change is directed, and optimized in terms of greater exports or more focused imports in relation to economic growth, and its quality also matters.

This is where the role of transaction costs and, in turn, institutions come to the fore, but which under neoclassical thought process is (wrongly) kept as exogenous to policy, left only to get affected indirectly by economic outcomes like growth and improvement of social capital.

Also, since the model wrongly assumes full employment, the growth and, in turn, employment sacrifice that control of credit growth through monetary- and fiscal austerity policies induces, is apparently not given enough importance to adopt an otherwise much more needed balanced approach between aggregate demand, and aggregate supply determined macroeconomic stability.

Moreover, by wrongly assuming that the country has no other choice than to follow a fixed exchange rate regime – which is the not the case – it expects that reserves will fall in the case of increase in credit growth almost automatically leading to increased imports, which need not be under between incentivization of that credit with people and business by providing better opportunities to invest, and also be being creative in restricting imports to more essential natured commodities for businesses, and consumers.

In addition, the book indicated with regard to the ‘Polak model’ that ‘Whether the causes of balance-of-payments instability were domestic or external, the model dictated austerity via contraction of domestic expenditures, which would be achieved by fiscal retrenchment and credit reductions.’

Indeed, practice of austerity policies has proved time and again over the years that while it calls for a lot of growth sacrifice, it negatively impacts otherwise important spending into the social sector, and together with the neoclassical worldview underlying this model, which, in turn, calls for a limited role of government, the result has been that the model – and in turn IMF programmes, which are based on this model – has remained at best only a short-term stabilizer for macroeconomy.

The book (rightly) remained critical of the austerity approach adopted through the ‘Polak model’, and indicated that ‘The real world of developing countries, however, is replete with large-scale unemployment. Employing such a model, which takes as given that all resources, including labour, are fully utilized, is therefore dubious in these cases.

In fact, policies based on this model have tended to contract economic activity and further exacerbate the already dismal standard of living. Recent empirical studies have confirmed the negative impact of IMF conditionality on economic growth. Moreover, this climate of austerity and credit constraint is hardly conducive to the types of investment needed for altering the structures of economies – an important key to development.’

As indicated, IMF policy formulation, in addition to the ‘Polak model’, also employs the ‘Swan-Salter model’, about which the book indicated the following: ‘…significant currency devaluations are seen to increase the return, in domestic currency terms, to tradable commodities, which therefore would induce higher levels of exports. This is assumed to universally improve balance of payments because exports are stimulated while import levels curtailed by the currency devaluation.’

Once again, this model has a number of drawbacks for developing countries in general, and also in the specific case of Pakistan, about which the book pointed out: ‘The model has several drawbacks, however – again, especially in the case of its application to developing countries – including its dismissal of structural weaknesses such as high dependence on imports, which would raise the domestic cost of production and counter inducements to export.’

Not only in terms of production, developing countries also depend on a large number of imports for important consumption needs like fillings gaps in essential natured food items like wheat, rice, baby food, on one hand, and energy-related imports like oil, and gas, all of which are also form an important determinant of overall inflation; not to mention remaining a significant source of external shocks to the economy. Here, energy-related imported inflation negatively impacts both production and consumption.

In addition, criticizing the model, the book pointed out: ‘…a country’s exports can be subject to fallacy-of-composition effect arising from the simultaneous expansion of exports by a number of “adjusting” countries with a significant market share.

When the exported goods have low elasticity, the dramatic increase in supply leads to a fall in price, which is not offset by sufficient demand stimulation; this leads to a decline in revenues. …Yet this strategy of expanding exports while devaluing currency was and still is strongly promoted by World Bank and IMF policies. Combined with trade liberalization… this strategy encourages countries to pursue their static comparative advantage which for developing countries tends to be the export of unprocessed raw materials (which is not surprising given their colonial history). Thus, rather than focusing on developmentally enhancing exports, which might encourage reorientation of economies towards industry and manufacturing and in turn help stimulate their structural transformation, developing countries are locked into the same problematic patterns.’

Prime Minister, Shehbaz Sharif, reportedly created a committee recently to reach proposals that may be taken up with International Monetary Fund (IMF) to allow a loose austerity emphasis in its currently ongoing extended fund facility (EFF) programme with the country. Such proposals are basically being required so that the country could enhance its economic growth to around 5 percent to 6 percent over the next two years.

The committee in the writer’s strong opinion should build their argument in particular over the seriously outlandish assumptions of the two models in particular, but also overall those of the neoclassical economics – which is the basis of these models in the first place – and should also question the justification of the Bretton Woods institutions in continuing to stick to this and related economic philosophies, given the poor record of the lending programmes shaped under the influence of this thought process over the decades, especially after the breakdown of the Bretton Woods system.

These philosophical underpinnings of the lending programmes by employing over-board neoliberal, and austerity policies have neither met their stated goals of sustained macroeconomic stability and economic growth, but have also unduly put a lot of pressure on the backs of the working class – in factories, or on farms, for instance – rather than reflecting more ambition, and right kind of policy prioritization; for instance, in the case of ongoing EFF programme, shifting fiscal austerity related targets from ‘binding’ conditionalities to ‘non-binding’ indicative targets, in addition to purging this conditionality of its ‘shock therapy’ nature.

Here, the committee advising the Prime Minister on how to successfully carry a non-neoliberal, and non-austerity-based agenda with IMF could learn from the comments made by New York Mayor, Zohran Kwame Mamdani, while delivering a press conference on January 28, regarding the fiscal situation of New York.

An excerpt from the press conference aptly puts forward the case as follows: ‘Working people did not cause this crisis, and they cannot be made the victims of its solution. In my inaugural address I made a promise. I said that we would overcome every moment of adversity together, and we would meet every moment of fiscal challenge with ambition, not austerity.

That promise stands. We will not shrink from this moment. We will not succumb to small ideas. We will meet this crisis with the bold solutions it demands. …time has come to tax the richest New Yorkers, and most profitable corporations. …We will be honest, transparent, and we will communicate the decisions we’re making, and why we’re making them. We have inherited a crisis from the past New York, but it need not define our future. …It will be difficult, but anything worth doing always is. …I think there is a difference between pursuing savings, and efficiencies, and pursuing austerity. And we are going to pursue every single saving, and efficiency that we can find, and we’re also going to do so in a manner that does not come at the expense of Working New Yorkers.’

Hence, the committee could suggest, in turn, a more ambitious policy that allows for greater role of public sector beyond just being a ‘fixer’ of market failures –being, in turn, a co-creator of markets with the private sector for reaching greater productive- and allocative efficiency needs, especially as the country is looking to improve economic, environmental and epidemiological resilience in particular in the face of fast-unfolding climate change crisis, and related ‘Pandemicene’ phenomenon – incentivizing larger private sector investment, especially into the real sector, creating deeper income- and wealth tax-related policy ingress, and putting in place an innovatively targeted import compression strategy that allows meeting exports- and growth enhancing importing needs. Overall, the country can ask IMF for allowing loosening of fiscal- and monetary austerity policies at the back of presenting a more ambitious role of government, and deeper and much more distributionally conscious revenue generating policies.

Last but not the least, basing its arguments on the criticism of the ‘Swan-Salter model’ – which primarily gives direction to the Bretton Woods institutions, and majorly contributes reasoning that underlies their programme conditionalities with regard to external sector policies, and the likely fallout for instance in terms of the impact of these policies on current- and fiscal accounts of the economy of programme countries – this committee may recommend to the Prime Minister and his economic team to ask IMF to not push for too much liberalization policies – of the nature of ‘shock therapy’.

This is because IMF in the current EFF programme calls for the country to adopt a market-based exchange rate regime, but instead the country should adopt a managed-float exchange rate, which, in turn, provides both predictability and allows authorities to safeguard against sharp devaluations, and also undue utilization of foreign exchange reserves to move very close to fixed exchange rate regime or even appreciate domestic currency artificially to support meeting conditionalities regarding fiscal, and current account through this channel.

Such shock therapy-natured liberalization policies also hinder economy moving from low-value adding traditionally comparative advantage commodities to higher-value adding, more import-substituting, and larger foreign exchange enhancing commodities and, in turn, reaching greater positive consequences for balance of payments, and fiscal balance.

(To be continued…)

Copyright Business Recorder, 2026