8. Develop a global partnership for development
8.2 The creaky international fi nancial architecture in the 1990s
By the mid-1990s the international financial architecture (IFA) as it had developed was a decidedly ad hoc affair, with different international and regional institutions having different responsibilities and practices. These were sometimes compatible (or even overlapping in the case of the World Bank and the RDBs) and sometimes not.
However, this IFA, and particularly the Bretton Woods institutions that sit at the heart of it, were heavily criticised, from both the Left and the Right.
What were these criticisms, however?
N. Africa & M. East − −0.3 −
SS Africa − −0.1 −
Other − 0.0 −
Source: UN (2005).
8.2.1 Critics from the Left
Box 8.4 The Washington Consensus
The phrase the ‘Washington Consensus’ was first used by the economist John Williamson at a conference at the Institute of Development Studies in 1989. Williamson (1990: 3) later set out ten policy areas that he thought there was general consensus on amongst the Washington-based institutions, notably the IMF and World Bank:
• ‘Fiscal discipline.
• A redirection of public expenditure priorities toward fields offering both high economic returns and the potential to improve income distribution, such as primary health care, primary education, and infrastructure.
• Tax reform (to lower marginal rates and broaden the tax base).
• Interest rate liberalization.
• A competitive exchange rate.
• Trade liberalization.
• Liberalization of FDI inflows.
• Privatization.
• Deregulation (in the sense of abolishing barriers to entry and exit).
• Secure property rights.’
Williamson (1999) complains that the term ‘Washington Consensus’
has come to mean something very different to that which he originally intended:
I have realized that the term is often being used in a sense signifi- cantly different to that which I had intended, as a synonym for what is often called ‘neoliberalism’ in Latin America, or what George Soros (1998) has called ‘market fundamentalism’. When I first came across this usage, I asserted that it was erroneous since that was not what I had intended by the term. Luiz Carlos Bresser Pereira patiently explained to me that I was being nạve in imagining that just because I had invented the expression gave me some sort of intellectual property rights that entitled me to dictate its meaning:
the concept had become the property of mankind.
Williamson raises an interesting point here. He saw the ‘consensus’
as a gradual convergence in thinking on the best ways to approach particular economic and financial policies, rather than the imposition of a ‘neo-liberal agenda’. However, it is also the case that the ‘intel- lectual convergence’ he speaks of does indeed represent such an agenda
for many people. Furthermore, it is one that many fundamentally dis- agree with. Most importantly, the ‘consensus’ has not remained an intellectual exercise by any means, but has formed the basis of struc- tural adjustment programmes implemented by the IMF and World Bank throughout the developing world. If it were the case that, in all cases, policy-makers in these countries completely agreed with the ‘suit’
of policies we could then talk meaningfully of a ‘consensus’.
However, where this has not been the case, the ‘consensus’ may indeed appear to be more like the imposition of a particular set of liberalising – or ‘neo-liberal’ – policies.
We have seen how the World Bank and IMF (and the RDBs to a lesser extent) increasingly focused on conditional, policy-based lending in the 1980s and 1990s, and it was this that was at the heart of criticisms of these institutions from the Left.
The major criticisms can be described as follows:
• It was (and is) argued that the IMF and World Bank are dominated by developed countries (particularly the United States) and the policies associated with their lending programmes reflect the interest of the dominant shareholders.
• The ‘Washington Consensus’ (see Box 8.4) of economic policies imposed by the BWIs – often described as ‘neo-liberal’ – were seen as serving Western interests.
• The IMF and World Bank were accused of having a one-size-fits-all approach to development, where the same policies were recommended to all countries regardless of their circumstances.
• For critics, the power and influence of the Bretton Woods institutions enabled them to force countries to implement these reforms, not least because financial support was conditional upon their doing so, regardless of their unpopularity with their citizens and negative social consequences that were seen to result.
• The lending programmes of both institutions resulted in increasing levels of debt in developing countries, particularly the least developed ones. As shown in Table 8.4 below, the servicing of these debts (for which further Table 8.4 Net transfers on debt owed to multilateral lenders, 1987–1994
1987 1988 1989 1990 1991 1992 1993 1994 World Bank 2.01 −0.71 −0.38 1.76 −1.50 −3.24 −1.19 −3.15
RDBs 1.85 2.28 2.79 2.27 3.37 2.70 2.09 −0.50
Source: Culpeper, 1997.
loans were often provided) resulted in negative resource transfers from the World Bank in the 1980s and 1990s.
• As can be seen, debt transfers over the period between the World Bank and developing countries were negative (−US$6.5 billion), but these were offset by positive flows from the RDBs (+US$16.85 billion).
More generally, critics argued that rather than reducing poverty levels, the actions of the World Bank and IMF have served to exacerbate the problem.
For example the ‘high water mark’ of structural adjustment programmes was in the mid-1980s, when many developing countries implemented Bank and Fund-inspired structural adjustment programmes.
Figure 8.3 shows that, for all developing countries, the percentage of the population of developing countries living in absolute poverty (i.e. less than US$1 per day) declined between 1981 and 1987. However, this does not tell the whole story by any means. In particular, the aggregate data is heavily skewed towards Asia because of the size of the population: the decrease in aggregate poverty levels therefore reflects the decline in poverty in the Asian region.
However, of all the developing regions, Asia was the least affected by the IMF/World Bank’s structural adjustment-type conditionality, so that the poverty reductions in this region cannot reasonably be ascribed to the imple- mentation of policies recommended by the Bretton Woods institutions.
In contrast, the regions that did implement many painful reforms – i.e.
Latin America and sub-Saharan Africa – at the instigation of these institu- tions saw poverty levels rise. In Latin America, the 1980s is known as the ‘lost decade’.
Figure 8.3 Absolute poverty, 1981 vs. 1987 (% of population on less than US$1 per day).
Source: World Bank WDI.
8.2.2 Critics from the Right
As well as being attacked from the Left, the Bretton-Woods institutions have also long been attacked from the Right. There are numerous reasons for this, ranging from the extreme position that the institutions represent a pseudo- world government in the making and have no legitimacy,15 to the specific policy recommendations where ‘supply-side’ economists argue that the IMF, in particular, recommends policies that are likely to be counterproductive to their aims.
Furthermore, and particularly since the LDC debt crisis of the 1980s, critics of the IMF have argued that its very existence promotes moral hazard among both borrowers and lenders, who make reckless lending and borrow- ing decisions in the knowledge that the IMF will arrive to bail them out in the event of a crisis occurring. As we shall see below, however, there is often a marked asymmetry in this argument, with moral hazard being seen as a more serious issue with regard to reckless borrowers (i.e. developing countries) than for reckless lenders (i.e. international financial institutions).
It was issues of this nature that underpinned debates on the reform of the IFA that occurred in the aftermath of the Asian crisis. This is the subject of the next section.
8.2.3 Reform of the IFA: the proposals
Following the turmoil of the Asian and Russian financial crises, there was much talk of fundamental reform. The international financial architecture as it had developed was widely viewed as inadequate to cope with the demands placed upon it by the modern financial system. Root and branch change was urged, though the ‘roots’ and ‘branches’ were often of very different forms.
In this environment, influential actors commissioned reports and proposed reforms. Although each of these reports and statements produced different proposals, they all focused on the role that lenders and borrowers had played in creating the major financial crises of the late 1990s. As discussed above, much was made of ‘moral hazard’: it was argued that when lenders (bor- rowers) are protected from the potential downside consequences of their lending (borrowing) decisions – by the probability of an IMF package that ensures they are bailed out in the event of a crisis, for example – they are liable to take insufficient account of risks and lend (borrow) recklessly.
There was considerable debate as to whether the crises had been largely triggered by reckless lending or reckless borrowing, however. The influential Meltzer Report (Meltzer, 2000),16 for example, repeatedly stressed the role of moral hazard in influencing borrowers’ behaviour. The Commission pro- posed numerous reforms, notably to the workings of the IMF, to rectify these problems, but the report was far more sanguine on the role of lenders.
The Council on Foreign Relations (CFR)17 and US Treasury Reports18
were both more balanced in this respect, with the former in particular arguing strongly for more private sector involvement (PSI) in post-crisis workouts: the argument was, and is, that if a private financial institution knows it will have to shoulder some of the costs of resolving post-crisis problems, they will take more care to avoid getting into such a situation in the first place.19
Other major studies commissioned at this time included the Geneva Report (1999),20 which was jointly published by the International Centre for Monetary and Banking Studies in Geneva and the Centre for Economic Policy Research (CEPR) in London, and the Ahluwalia Report, which was commis- sioned by the G24 and written by the economist Montek Ahluwalia in 1999.
A further major report was also published in 2000 by the Washington-based Overseas Development Council (ODC).21
The most obvious point to make at the outset is that the events of the Asian crisis and its aftermath were clearly being taken very seriously indeed.
Furthermore, all of these reports focus – to a greater or lesser extent – on the role of the IMF. The Meltzer Report also considers the role of the World Bank, the RDBs, the WTO, and the BIS, but it too focused primarily on the IMF. Clearly the role of the Fund was viewed as being of primary import- ance, both in terms of avoiding financial crisis in the first place, and of resolving crises if they do occur.
Williamson (2000) reviewed these reports, separating their findings into recommendations of different aspects of the IMF’s activities. Below, we briefly consider the conclusions.22
(a) Scope of the IMF
In one respect there was broad agreement that the IMF’s activities exhibited pronounced ‘mission creep’, with the Fund having taken on more and more functions. All the reports recommend that the IMF should therefore narrow its approach and focus on its ‘core competencies’, such as surveillance, the promulgation of financial standards and the maintenance of macroeconomic stability. The view that the Fund should retain a key role in preventing and managing financial crises was also broadly expressed.
Whilst there is common ground in some regards there is certainly no unani- mity. For example, while the Meltzer Report calls for a fundamental reduc- tion in the Fund’s activities, the other reports argue that the IMF should have a major role in (a) promoting macroeconomic coordination between its members, for reasons of global economic stability, and (b) preventing the development of crisis potential in developing and emerging economies. The Meltzer Report, in contrast, starts from the proposition that IMF lending promotes moral hazard (suggesting that the importance of this ‘cannot be overstated’). Indeed, a dissenting majority within the committee argued that the IMF should be disbanded.
The other area of disagreement relates to the role of the ‘Poverty Reduction and Growth Facility’ (PRGF), which is overseen by the IMF. For some
(Ahluwalia; ODC) the facility should be moved to the World Bank. For the Meltzer Report, the PGRF should be simply disbanded.
(b) Surveillance
The IMF undertakes two forms of surveillance:
1 surveillance of the world economy, as published in the World Economic Outlook reports;
2 surveillance of individual member countries.
All the reports were happy for the Fund to continue with (1), and despite differences of emphasis, broadly agree with surveillance of individual coun- tries as well. Most wanted to see greater transparency in this area though, with a particular emphasis on all surveillance reports being published.
(c) Lending
The main questions in this regard were: (a) whether the IMF should provide financing to members affected by crisis; (b) on what terms this financing should be provided; and (c) whether countries should have to ‘pre-qualify’ for assistance, which would then replace the conditionality associated with IMF lending today.
The last of these points (pre-qualification) encapsulates the nature of the debate. In the Meltzer Report, for example, pre-qualification is essential in order to reduce the moral hazard associated with IMF lending – if a country ignored warnings about the risks of its activities, and therefore could not pre-qualify, it would not be entitled to IMF support.
The Meltzer Commission suggested the following criteria for pre- qualification:
• freedom of entry and operation for foreign financial institutions;
• well-capitalised commercial banks, preferably with part of the capital in the form of uninsured subordinated debt;23
• regular and timely publication of the maturity structure of outstanding sovereign and guaranteed debt and off-balance sheet liabilities; and
• a sustainable fiscal position (though it was not specified what this means in practice).
Countries that were able to meet these criteria would be entitled to borrow freely, but at a high rate and for short durations – 120 days maximum, with only one rollover permitted. The ‘penalty rate’ would be ‘a premium over the sovereign yield paid by the member country one week prior to applying for an IMF loan’. However, as Williamson (op. cit.) points out, given that sovereign yields are almost certain to rise sharply prior to the onset of a crisis, this
seems implausible.24 Those who did not meet the criteria would be entitled to no assistance at all.
More broadly, the Meltzer Commission argued that the IMF’s lending role should be restricted to this lender-of-last-resort function, which would only be available to solvent, middle-income countries – that is, the Fund should not lend to the poorest developing countries, nor to developed countries.
The other reports listed above agreed that the Fund should focus on lend- ing in crisis situations. However, they were by no means as restrictive as the Meltzer Commission in this respect. The Geneva Report, for example, expressed scepticism on the merits of pre-qualification, which it viewed as being solely designed to prevent moral hazard. For the authors, the moral hazard issue certainly can be ‘overstated’25 – given the hugely negative impact of a financial crisis, it was argued, no government would risk such an event occurring with or without IMF support.
The ODC report also argued that the Fund should focus on lending in crises, but that all countries should be able to borrow in the event of a macro- economic crisis: the pre-qualification approach was therefore rejected.
The CFR Report suggested that the Fund could distinguish between
‘country crises’ and ‘systemic crises’. In the former case, financial support would be restricted to the usual IMF quota limits (see above, p. 257), whereas systemic crises – where countries affected by contagion through no fault of their own – would be able to access a newly established ‘contagion fund’, based on newly allocated SDRs. For country crises, IMF conditionality would apply. For contagious, systemic crises, this would not be the case.
The CFR and Geneva Reports both stress the importance of involving creditors in restructuring of debts as a condition of IMF support. In this regard, the Geneva Report argues that IMF financing should be available on more favourable terms to those countries whose bond contracts contain ‘col- lective action clauses’, which enable the terms of the bonds to be restructured in the event of a crisis, as negotiated between debtors and a given majority of creditors.26
Just as the Meltzer Report stressed the moral hazard associated with reck- less borrowing, these two reports emphasise the other side of the equation:
that is, moral hazard-induced reckless lending. It is noteworthy that the Melt- zer Report is almost silent on the issue of ‘private sector involvement’ (PSI) in this regard: it would appear that the Commission considered that moral hazard only affects borrowers, whereas lenders seemingly make rational, eco- nomically objective decisions in every instance and are therefore immune to moral hazard.
(d) Governance
Williamson (op. cit.) also considers the reports’ views on IMF governance, which we have discussed previously in this chapter. Despite the importance of the issue, they have little to say, beyond calls for greater transparency.
(e) Non-IMF related proposals
As pointed out above, the Meltzer Commission did not restrict its proposals to the IMF. Recommendations for other international and regional institu- tions were as follows.
THE WORLD BANK AND THE REGIONAL DEVELOPMENT BANKS
All resource transfers to countries that enjoy capital market access (as denoted by an investment grade international bond rating) or with a per capita income in excess of $4000, would be phased out over the next 5 years. Starting at $2500 (per capita income), official assistance would be limited. (Dollar values should be indexed.) Emergency lending would be the responsibility of the IMF in its capacity as quasi lender of last resort.
This recommendation assures that development aid adds to available resources (additionality).
(Meltzer, 2000: 11) Beyond this, the World Bank and RDBs should focus on technical assist- ance, the provision of regional and global public goods, and the facilitation of an increased flow of private sector resources to middle-income countries.
Furthermore, loans to the poorest countries should be replaced by grants, with the important proviso that a country’s ability to access these grants depends on their record of delivery: ‘. . .poverty is often most entrenched and widespread in countries where corrupt and inefficient governments under- mine the ability to benefit from aid or repay debt. Loans to these governments are, too often, wasted, squandered, or stolen.’ (p. 12)
To reflect this change in focus, the Commission recommends that the World Bank’s name be changed to World Development Agency.
In terms of division of responsibilities between the Bank and the RDBs:
All country and regional programs in Latin America and Asia should be the primary responsibility of the area’s regional bank. The World Bank should become the principal source of aid for the African continent until the African Development Bank is ready to take full responsi- bility. The World Bank would also be the development agency respon- sible for the few remaining poor countries in Europe and the Middle East.
(p. 13) The report also argued that all bilateral and multilateral debt to the HIPC countries should be written off, for countries that ‘pursue effective economic development strategies,’ as judged by the Bank.