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Volume XXXIII No. 4 (October-December 1998)
Do International Financial Institutions have a Future?
By Mario Sarcinelli
The second world war had not yet finished—it was 1944—when the United States decided to call a conference at Bretton Woods, New Hampshire, to rebuild the international monetary order which the fall of the gold exchange standard, the capital controls and the trade protectionism that followed the great depression and, finally, the global conflagration had destroyed. That conference, the site of a memorable debate between the American Harry White and the British John Maynard Keynes, led to the creation of two international institutions: the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD), later known as the World Bank. The initial participation of only the victorious Western powers was subsequently enlarged to the countries that had lost the war, then to territories that freed themselves of the colonial yoke and some centrally-planned economies and, after the fall of the Berlin Wall and communism, to all the economic and political systems in transition towards the market and democracy. Today, the IMF has 182 members.
The World Bank was charged with the task of gathering funds on the markets and granting the public authorities of countries destroyed by the war and engaged in promoting reconstruction loans on rather favourable terms due to the guarantee extended to the bond bearers by the countries participating in the IBRD capital. When reconstruction was completed in the fifties, the economic development of the Third and Fourth Worlds became the World Bank’s prime objective, as it was gradually supplanted by the International Development Association (IDA) in the concession of soft credit to countries that were unable to pay market interest rates, the International Finance Corporation (IFC) in financing operations typical of the private sector on market terms, the Multilateral Investment Guarantee Agency (MIGA) in the concession of guarantees, etc.
The Cold War, the lack of solid economic institutions and the instability of the policies had a negative influence on development in those countries in which the World Bank operated and results were, in fact, often unsatisfactory. Since then, the accumulation of debt by recipient countries, the protests of ecologists against works thought to destroy the environment, the persistence and worsening of poverty even in major areas where the process of development had been positive, the doubts that have arisen about a development model based rather simplistically on the accumulation of capital and, above all, the reawakening of economic liberalism, which considers any state and public sector intervention in the economic field a distortion, have undermined the role and the image of the World Bank. If one adds that with the debt crisis in the eighties, part of the loans became policy-based, the World Bank’s original identity as a project financing institution is definitely tarnished. It is not surprising, therefore, that there have been calls for its reform or even for its suppression, both matters that will be briefly dealt with later.
Let us look now at the International Monetary Fund. Although it became the object of criticism only later, accusations have become particularly scathing recently, since the spreading instability that seems to characterise the globalised world has dealt a blow to the credibility of the multilateral institutions that have supposedly supervised the economy of the planet for the last fifty years. As set down in the IMF’s Articles of Agreement, the institution’s five main purposes are as follows.
If these objectives still seem valid, at least at first glance, why has there been such strong criticism of the IMF and its operations, to the point that some people are calling for its closure? Critiques can be classed into two groups: those in the first group concern the programmes that have been prepared to solve the crisis in countries like Thailand, Indonesia, South Korea and above all Russia; those in the second have to do with the functioning of the international monetary system, the possibility of limiting contagion and, above all, the exorcising of the moral hazard entailed by the public resources the IMF makes available.
Criticism of programmes have been concentrated on the fact that interest rates were pushed up to stabilise the exchange rates which, at least in South Korea and Thailand, have returned to 35-40 percent of their pre-crisis levels, while interest rates have settled at 8-9 percent, also below what prevailed before the crisis. It is obvious, however, that if interest rates had not been driven up so drastically, devaluation of national currencies would not only have been permanent, but also much greater, with a further deterioration of the financial situations of countries with debt in dollars. And it should not be forgotten that a more drastic devaluation could have triggered reactions from importing countries which have to contribute with their purchases to restoring the trade balance of crisis-stricken countries.
Another accusation concerns the size of the budget surplus demanded of Thailand (3 percent of GDP) which had a current accounts deficit of 8 percent of GDP. Stanley Fischer, the deputy managing director of the IMF, acknowledges that if they had been aware, when signing the programme with Thailand, of the further slowdown in Japan and the rest of Asia, the IMF would have asked for a smaller reduction in public demand.
Yet another involves the inclusion in the programmes of structural measures which, by their very nature, require time to bear results. But even here, as long as their introduction does not interfere with the stabilisation process, why postpone it—especially in consideration of the long time span required?
All these critiques received a great deal of comment, also because the programmes did not work as well as expected. But this was due, on the one hand, to political uncertainty—in all three countries the process of stabilisation only started with the advent of new governments which guaranteed the implementation of the plans agreed upon—and on the other, to insufficient knowledge, for example, of the foreign debt level of Korea. Political problems were certainly very serious in Indonesia, where the long reign of President Suharto and his clan was brought to an end by street demonstrations, but in no country were they more predominant than in Russia, where successive governments have been too weak to ensure tax collection. In 1997, the federation’s tax revenues were equal to 9.7 percent of GDP, while the budget deficit was equal to 6.9 percent of the same aggregate. While short-term debts in rubles, the so-called GKO increased almost daily—since 1994 the interest rate on these securities had been 50 percent on average—the fall in the price of oil and other raw materials forced the Russian government, despite a 22 billion dollar programme agreed upon on the condition that Russia would undertake a profound fiscal reform and a voluntary restructuring of short-term debt, to devalue the ruble, to impose a unilateral restructuring of GKO and to decree a moratorium on private debt servicing. The IMF’s justification in the case of Russia is that it was well known from the start that this was a major gamble that neither the international community nor the IMF could afford to turn down. An atomic arsenal, under ever less safe conditions, is there to remind us of the risks we run and the price that has to be paid...
The kind of criticism that falls into the second group is, instead, radical. The forerunner is Milton Friedman who recently wrote that it is better for a developing country to have a full-fledged fixed exchange rate system without a central bank or a flexible one with a good national central bank than a pegged system. The choice depends on the specific characteristics of the country involved and, in particular, on the presence of an important trade partner with a stable monetary policy whose currency can support the national currency. Friedman goes on to state that the IMF has been a destabilising factor in East Asia, not for the more or less favourable conditions it imposed on its clients, but because it protected private financial institutions from the consequences of rash investment. He concludes that if the IMF had not existed, there would have been no Southeast Asian crisis, perhaps only crises in individual countries.
While Friedman does not explicitly call for the dissolution of the IMF, Jeffrey Sachs does and recommends the establishment of a G-16 (the G-8 plus eight emerging countries), the introduction of controls by developing countries on the short-term international indebtedness of their national financial institutions, recourse in case of crisis to an across-the-board reduction in debts of countries in difficulty and/or a massive conversion of debts into stocks and, above all, total adhesion to a floating exchange regime. He asserts that if this plan were implemented, it would put an end to bail-outs by the IMF, like the ones that failed in Asia and Russia. They just do not work, he says, and with this plan they would no longer be necessary. In other words, he suggests abolishing the IMF’s fifth purpose. As for the World Bank, the same author proposes transforming it into the main international institution to mobilise the knowledge needed to deal with the problems of the developing countries (for example, the fight against malaria). But this would only take place after the G-16 had promoted cancelling most of the debt of the poorer countries and the World Bank had privatised its credit portfolio; hence it would no longer finance infrastructures, which would be taken over by the market.
Not all analysts agree with this diagnosis and propose such a revolutionary cure. Paul Krugman, for example, claims that the causes of the Southeast Asian crisis must be sought in the weakness of fundamentals and that, rather than push through measures aimed at reassuring the markets, it would be best to re-establish orderly macroeconomic conditions in the countries at risk; if the latter are stable, then the markets will also be calm. Speculator/philanthropist George Soros has become very sceptical of the way in which global capitalism has been expanding and suggests a return to flexible regulation in addition to the establishment of an international agency for insuring international loans.
Faced with this variety of positions, what can we expect from the future? In my opinion, nothing dramatic, as shown by a careful reading of the declarations of American President Clinton, British Prime Minister Blair and French Finance Minister Strauss-Kahn (if one excludes the latter’s insistence on political leadership of the IMF through the institution of a Council that would take decisions by vote). Even the G-22, which includes both developed and emerging countries, may be effective in urging those responsible for financial regulations to find a way to contain the contagious effects by ensuring greater transparency of countries’ positions and determining at what point financial leverage becomes too great. Indeed, more complete information should increase the efficiency of international capital markets. To that end, the IMF is attempting to obtain better data on official reserves and on future and forward operations of central banks, and the Bank for International Settlements (BIS) and other institutions are trying to make information on short-term debt available.
As regards moral hazard, we are just going to have to acknowledge that it cannot be eliminated, unless we abolish all kinds of public, national or international intervention, which could, perhaps, reduce the number of crises, but at the cost of their being more serious when they do occur. Therefore, all we can do is improve the compromise by involving the private sector to a greater degree (bailing in), by adapting IMF programmes in light of recent experiences and, in particular, by increasing transparency in the Fund itself as concerns deciding on, activating and supervising its programmes. But my answer to the question in the title is, yes, there is a future for the Bretton Woods institutions. Despite calls for a new architecture, whatever materialises in the coming months will be a mere series of management improvements to adapt them to the globalised world of the rapidly approaching Third Millennium.
Mario Sarcinelli is the former President of the Banca Nazionale del Lavoro. Translation is by Gabriele Tonne.