8. Develop a global partnership for development
8.3 Reform of the IFA – what has happened since?
With the benefit of some distance from the Asian crisis that was the catalyst for the debate on reform described above, Griffith-Jones and Ocampo (2003) argue that the architecture has – or should have – five functions.
Specifically, it should:
1 guarantee the consistency of national macroeconomic policies with sta- bility and growth at the global level as a central objective;
2 ensure appropriate transparency and regulation of international financial loan and capital markets, and adequate regulation of domestic financial systems and cross-border capital account flows;
3 ensure the provision of sufficient international official liquidity in crisis conditions;
4 create and maintain accepted mechanisms for standstill and orderly debt workouts at the international level;
5 develop appropriate mechanisms for development finance.
With the possible exception of point 5, all of these have seen recommenda- tions for reform, many of which are described above. The authors go on to give four reasons why progress on reforms has been so disappointing:
(a) No agreed upon international reform agenda
As we have seen there are considerable differences in the proposals for reform.
However, as demonstrated by the difference between the EMEPG Report and the others in the previous section, the largest gap – in terms of agreeing an agenda – appears to be between developed countries, on the one hand, and emerging and developing countries, on the other. Clearly, if there is no agree- ment on what the problems are, there can be little hope of progress on finding solutions.
(b) Progress has been asymmetrical
To date the focus of reforms has been on strengthening national econo- mic, financial and regulatory frameworks within developing and emerging economies. For example, developing countries have broadly accepted the implementation of internationally recognised codes and standards for macroeconomic and financial regulation, as designed by the Financial Stabil- ity Forum. However, there has been little if any progress in reforming the international aspects of the IFA. This would only be sufficient if the sole cause of financial instability and crises were policy deficiencies in developing countries. However, as is broadly accepted, this is not the case: a country with perfect fundamentals and regulation can still be affected by a self-fulfilling crisis, and/or by contagion from another crisis.
Similarly, there has been no real progress on macroeconomic coordination (particularly among G7 countries as called for by the EMEPG Report) to reduce the build-up of crisis potential. This situation has improved somewhat in recent years, with the launch of the IMF’s ‘Multilateral Consultation Pro- cess’ in 2006. The initiative brings together relevant countries – depending on the nature of the issue – to discuss mutually beneficial solutions and increase the prospect of cooperative action to resolve problems. The first Consultation focused on correcting global economic imbalances, and saw five countries (or country groups) take part: China, the Euro Area, Japan, Saudi Arabia and the United States.
It is too early to say what the outcome of this process will be. The fact that the Fund cannot compel countries to change their economic policies
(not least as these countries do not borrow from the IMF and cannot therefore have conditions imposed) suggests that prospects of success turn on whether the Fund can convince participants that change is in their com- mon interests. Intuitively, it is likely that this will be the case in some instances but not in others. For example, perhaps the largest imbalance the global economy faces today is the trade surpluses in East Asia, the trade deficit in the US and the resulting build-up of foreign exchange reserves in the former.
However, many have argued that the recycling of these reserves into US Treasuries has effectively been a process where the East Asian economies lend the US the funds needed for it to purchase their imports. In many ways, therefore, this situation suits both parties and, although it may not suit the others at the table, consensus will surely be needed before major change occurs.
Also, while considerable effort has been put into developing and modifying the various IMF financing facilities (which was the focus of the Washington- based reports described above) there has, as we saw in the previous chapter, been far less progress on international debt workout agreements that involve
‘burden-sharing’ between creditors and debtors.
A second asymmetry that is identified is the focus on crisis prevention and management in middle-income countries, at the expense of developing mechanisms to encourage stable, long-term financial flows to the poorest LDCs.
The reforms that have occurred, such as the introduction of codes and standards, for example, reflect the perspective of developed countries. Those that have a more developing country slant – burden-sharing, regulating hedge funds, and so on – have made little or no progress in comparison.
(c) The IMF may not have sufficient resources to perform its key task
Despite the fact that most commentators (even Meltzer) agree that the IMF needs access to more funds to manage crises better, there has been a growing reluctance amongst developed countries to support large-scale IMF lending.
The primary rationale for this is the desire to avoid moral hazard which was central to the Meltzer Report, as we have seen.
The crises of recent decades have demonstrated that the scale of inter- national financial markets today is such that to provide sufficient resources to enable a country to (a) deter a speculative attack, and/or (b) rebuild their financial infrastructure following a crisis requires a far greater level of finan- cing than was the case in the past.
Figure 8.4 below shows that although the resources available to the Fund have increased steadily since its foundation, in relative terms – i.e. as a per- centage of the size of the global economy – the opposite has been the case.
Thus, while in 1944, IMF resources were equivalent to more than 3.5% of its members’ GDP, by 2003 this had fallen to 0.9%.
As Buira (2006) points out, IMF members – particularly emerging markets
– that face severe external financing difficulties do not typically have access to private capital markets at these times. The burden therefore falls directly on the Fund.
Furthermore, contagious or region-wide crises – of the kind seen in Asia in the late 1990s – have the potential to stretch these resources to the limit. A fundamental difference between a national central bank acting as a lender-of- last-resort and the IMF taking on a similar role, is that the Fund does not have the ability to issue its own fiat currency. Thus, while a national central bank can – in theory at least – provide as much support as is required, the support that the IMF can offer is limited to that which its members can provide.
As is shown in Figure 8.4, in relative terms this has been falling steadily, while at the same time the size of the potential call on IMF resources has risen hugely. Given the current disagreements on the role of the Fund, and even the fact of its existence – particularly in the political circles of its largest contributor, the US – there seems little chance of this trend being reversed in the foreseeable future.
(d) Reform of IFA characterised by insufficient developing country representation
The international bodies responsible for reforming the IFA (IMF, World Bank, FSF and BIS) have very limited representation for developing and emerging economies. In the case of the IMF and World Bank this is a func- tion of historical precedents, the time lag in adjusting voting rights to reflect modern economic realities, and the unwillingness of developed countries to dilute their control over these institutions.
Figure 8.4 IMF resources vs. members’ GDP, 1944–2003.
Source: IMF WEO.
The BIS, in contrast, started out as a forum for developed country central bankers, and while its edicts – particularly those of the Basel Committee on Banking Supervision – have come to be the international standard adopted by all countries regardless of their level of development, developing and emerging economies are generally only afforded ‘consultant’ status, rather than being full members. A similar, semi-detached status is afforded to devel- oping countries in the FSF, which is perhaps even more unreasonable than the case of the BIS, since many of the codes and standards promulgated by this body are directed almost exclusively to low- and middle-income countries.
Griffith-Jones and Ocampo (op. cit.) describe the following areas where good progress on reform has been made:
• the development of C&S and standards for crisis prevention in capital recipient countries;
• the design of new IMF financial facilities;
• the HIPC Initiative aimed at bringing external debts of low-income countries to sustainable levels.
Areas of limited progress are:
• macroeconomic surveillance and mechanisms to guarantee the coherence of macroeconomic policies;30
• improvements in worldwide regulatory standards;
• the redefinition of IMF conditionality.
Areas of no progress are:
• the use of SDRs as an instrument of IMF financing;
• the design of international standstills and workout procedures;
• development finance;
• regional schemes in all areas of the financial architecture.
The factor that may, at least in part, explain the asymmetric nature of these reforms is the lack of developing country participation in the relevant inter- national bodies that determine reforms and set standards. Without a seat at the table – and therefore an effective veto over decision-making – the concerns of developing and emerging economies are very unlikely to be prioritised.
This is basic political economy and it has been ever thus.
Concluding remarks
In this chapter we have examined the birth, evolution and current state of what has come to be known as the international financial architecture. As we have seen, the current patchwork of international and regional institutions that we have today was widely viewed as being incapable with dealing with the
realities of modern financial crises in the period after the Asian crisis. Root and branch reform was proposed from many different directions, often in ways that were mutually incompatible.
Since that time, however, not much has actually happened, and what has happened has largely focused on reducing the vulnerability to crises in devel- oping countries. Furthermore, as the scale, duration and impact of financial crises has risen sharply, the measures deemed necessary for a country to protect itself from such events have widened commensurately.
This would be fine if the sole cause of such events lay in policy errors in countries that are recipients of capital flows. However, with the exception of a very limited number of commentators, nobody, it seems, thinks this is the case.
As well as the recipients of capital flows, it is surely the case that countries that are the source of these outflows have a greater role to play. However, as we have seen, there is little agreement on what measures should be taken, with perhaps the most marked divide being between commentators from recipient countries and those from source countries.
A final point to make relates to the political economy of this situation.
Financial crises disproportionately affect low- and middle-income countries, while richer countries – which are the source of most international capital flows – receive considerable benefits from the financial centres which they host. Similarly, while richer countries may provide the bulk of the financing for the multilateral financial and development institutions, it is in poorer countries that they largely operate.
9 Development fi nance and the private sector
Driving the real economy
Introduction
We have seen throughout this book how ensuring an appropriate level of development finance requires both domestic resource mobilisation and a suitable level of external capital inflows, from both the private and official sectors. Furthermore, we have seen that it is not just the level of total finance available but the composition of this financing that determines the ultimate developmental impact.
As was stressed from the outset, financial sector development is not an end in itself. Its sole purpose – which must always be borne in mind, but is too often forgotten – is to facilitate developmentally beneficial activity in the real eco- nomy, and so contribute to national economic progress and poverty reduction.
Success or failure should thus be judged purely against this criterion.
In this regard, a fundamental issue to consider is the mechanisms through which this financing – and its ancillary benefits and/or costs – is trans- mitted to the private sector in developing countries. Accordingly, in this penultimate chapter we will consider these issues, with a particular focus on financing small-and-medium-enterprises (SMEs) which, as we have seen, are of paramount importance in developing and emerging economies.
When we consider financing options for the private sector, a very import- ant issue relates to the capital structure of firms. Of course this is something of a chicken and egg situation: the financing is available in different environ- ments is likely to shape the capital structures that firms adopt. Conversely, the capital structures that prevail will also be influenced by factors other than the availability of particular forms of finance, and this in turn will influence the type of financing that is desired.
Accordingly, the first section will consider some broad issues regarding differences in financial structures internationally.