IMF programs: Who is chosen and what are the effects?

IMF loans react to economic conditions but are also sensitive to political-economy variables. Loans tend to be larger and more frequent when a country has a bigger quota and more professional staff at the IMF and when a country is more connected politically and economically to the United States and other major shareholding countries of the IMF. These results are of considerable interest for their own sake. More importantly for present purposes, the results provide instrumental variables for estimating the effects of IMF loan programs on economic growth and other variables. This instrumental estimation allows us to sort out the economic effects of the loan programs from the responses of IMF lending to economic conditions. The estimates show that a higher IMF loan-participation rate reduces economic growth. IMF lending also lowers investment but raises international openness. In addition, greater involvement in IMF programs tends to lower the rule of law and democracy. We conclude that the typical country would be better off economically if it committed itself not to be involved with IMF loan programs. *This research has been supported in part by a grant from the National Science Foundation. We appreciate comments from Alberto Alesina, Eduardo Borensztein, Jeffrey Frankel, Jeffrey Frieden, Jinyong Hahn, Mohsin Kahn, Myoung-jae Lee, Greg Mankiw, and seminar participants at the Australian National University, Harvard University, the International Monetary Fund, the Korean Econometric Society Workshop, the State University of New York at Buffalo, and Tokyo University. Yunjong Eo provided valuable research assistance. In recent decades, many countries have participated in loan programs of the International Monetary Fund. In fact, almost all developing countries have received IMF financial support at least once since 1970. The few exceptions include Botswana, Iraq, Malaysia, and Kuwait. Given the broad reach of IMF loan programs, it is important to know the consequences of these programs for economic growth and other dimensions of economic performance. Do countries benefit from access to IMF loan programs or would countries be better off if these programs did not exist? The main difficulty in answering this question is that IMF loans tend to be made in response to economic problems. This response, akin to a doctor administering to a sick patient, tends to generate a negative association between IMF loan programs and economic performance. Obviously, it would be unfair to blame the IMF for these pre-existing bad conditions. Thus, to assess the economic effects of the loan programs, one has to sort out the directions of causation, that is, distinguish the economic effects of the loans from the effects of economic conditions on the probability and size of the programs. Similar issues arise in evaluating foreign aid, debt relief, and other programs that respond to the economic health of a country. To sort out the directions of causation, we would ideally observe experimental situations in which the IMF introduced a loan program without regard to a country’s economic conditions. We try to approximate these sorts of experiments by taking a political/institutional approach to the IMF’s decision-making. That is, we construct and use some political and institutional variables that, first, have substantial predictive value for IMF loan participation and, second, are arguably exogenous with respect to economic