8. Develop a global partnership for development
8.1 The Bretton Woods institutions
Although representatives of forty-four countries gathered at Bretton Woods in New Hampshire in 1944, there were, in reality, only two key figures: John Maynard Keynes from the UK and Harry Dexter White of the US. The aim was to construct an international economic and financial system that would reduce instability, particularly in relation to the competitive currency devalu- ations that had marked the inter-war years, and the prevalence of restrictive bilateral trade agreements at that time. These factors, it was thought, had contributed directly to the Wall Street Crash, the Great Depression and so, ultimately, to the onset of the Second World War.
The time was one of faith in the power of the state to achieve desirable goals that the market, left to itself, was now seen as incapable of producing. The earlier faith in the ability of unfettered markets to produce optimal outcomes had been shattered by events, and the ability of governments to successfully manage capitalist economies directly had been demonstrated by the recent wartime experience.
At this time, the United States was the only major developed economy that remained intact – and was even strengthened – by the events of the war. This greatly enhanced the US’s bargaining position – not least as it was the only major source of reconstruction funds in the then foreseeable future – which ensured that its viewpoints were largely reflected in the institutional structures that resulted.
These negotiations resulted in the birth of the three key Bretton Woods institutions1 the International Monetary Fund (IMF), the International Bank for Reconstruction and Development (IBRD, which was to become the World Bank) and the General Agreement on Trade and Tariffs (GATT), which was to become the World Trade Organisation (WTO).2 Each of these institutions had a specific function within the new system for international economic governance.
However, it should not be assumed that these institutions emerged into a vacuum: at their inception, they were just three institutions within a network of around 300 organisations, which were designed to address international economic matters, both regionally and globally. The most significant of these were: the Organisation for Economic Cooperation and Development (OECD), the European Economic Community (EEC) and the Bank for International Settlements (BIS).
8.1.1 The International Monetary Fund
The role of the International Monetary Fund (IMF) was to create a stable environment for international trade through encouraging the coordination of member countries’ monetary policies and ensuring exchange rate stability.
This latter function entailed the oversight of the post-war system of fixed exchange rates, where international currencies were pegged to the US dollar,
which was in turn pegged to gold at US$35 per ounce. To support these efforts, the Fund was mandated to provide short-term financial support to countries experiencing temporary balance of payments difficulties.
The IMF was born in December 1945, when the first twenty-nine countries signed its ‘Articles of Agreement’.3 Member countries of the IMF were required to pay a ‘quota’ to the Fund, the size of which was based on the country’s GDP. Each country’s quota determined the amount of IMF finan- cing it could access and, as well, its voting weight within the Fund. For voting rights, each member had 250 ‘basic votes’ plus one additional vote for each US$100,000 of quota (later changed to 100,000 Special Drawing Rights [SDRs]).
The allocation of basic votes was designed to ensure that smaller member countries still had an audible voice within the IMF’s decision-making bodies.
In 1945, these forms of voting rights accounted for 11.3% of total votes.
As the number of members grew, this initially caused the size of this block of votes to rise. For example, by 1956 the Fund’s membership had risen to sixty-eight and the block of ‘basic votes’ then accounted for 15.6% of total votes, giving smaller countries greater influence. However, subsequently, the growth of the world economy and inflation combined to massively increase the relative importance of ‘quota votes’ (i.e. those based on a country’s shareholding in the IMF, which is based on its relative economic size). By the turn of the twenty-first century, these factors had reduced the block of basic votes to around 2% of total voting, greatly reducing the influence of smaller countries and increasing that of the Fund’s economically largest members (Buira, 2002).
The IMF’s Articles of Agreement have been modified on a number of occasions since 1945. Today there are thirty-one Articles of Agreement, which cover a range of issues including: membership, quotas and voting rights, members’ obligations, financing, IMF operations, special drawing rights (SDRs), emergency provisions and so on.
While there have a series of modifications of different Articles, Article I, which describes the purposes of the IMF, remains unchanged:
(i) To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collabor- ation on international monetary problems.
(ii) To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.
(iii) To promote exchange stability, to maintain orderly exchange arrange- ments among members, and to avoid competitive exchange depreciation.
(iv) To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination
of foreign exchange restrictions which hamper the growth of world trade.
(v) To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus pro- viding them with the opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.
(vi) In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members. 4
Point (iv) above, might suggest that membership of the IMF precludes the use of capital controls. However, this is not the case today, and historically the opposite was almost true: at its inception, there was a concerted effort from Keynes for the IMF to require members to implement controls of capital flows.
This was rejected by the US, however, and the final Articles gave countries the option of doing so.
Article IV, which deals with ‘Obligations regarding exchange arrange- ments’, states that:
Recognizing that the essential purpose of the international monetary sys- tem is to provide a framework that facilitates the exchange of goods, services, and capital among countries, and that sustains sound economic growth, and that a principal objective is the continuing development of the orderly underlying conditions that are necessary for financial and economic stability, each member undertakes to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates.
But the more specific references to capital transfers in Article VI, which deals with ‘Capital transfers’, clarifies:
Members may exercise such controls as are necessary to regulate inter- national capital movements, but no member may exercise these controls in a manner which will restrict payments for current transactions or which will unduly delay transfers of funds in settlement of commit- ments, except as provided in Article VII, Section 3(b) and in Article XIV, Section 2.
Under Article IV, the Fund has always been charged with the task of ‘surveil- lance’ of members’ exchange rate regimes, in order to ensure the effective functioning of the international financial system. However, the key issue to bear in mind is that in this respect – as in many others – the IMF’s role in the international financial system has changed radically since its inception. The focus at the outset was ensuring that the system of fixed exchange rates
inaugurated at Bretton Woods was maintained, thus facilitating the growth of the international trading system. However, with the collapse of the fixed exchange rate system in the early 1970s, the IMF has sought a new rationale for its existence.
In the early 1980s, the LDC debt crisis provided an opportunity in this regard, and the Fund was instrumental in organising the Mexican rescue package that was described in Chapter 7. Since then, the IMF has retained its focus on ensuring the stability of the international monetary system, but what has led to major changes in the way the Fund approaches this has been an evolving understanding of what is needed to achieve this goal. In particular, the areas of interest to the Fund have progressively broadened since the 1970s.
In 1977, for example, the IMF’s remit with regard to surveillance was considerably expanded, after the Executive Board decided that, in order to undertake a complete appraisal of exchange rate policy, the Fund would need to perform a comprehensive analysis of the general economic situation and policy strategy of each member country. This entailed an amendment to the IMF’s Articles, which: ‘also emphasized that the ultimate objective of surveil- lance is to help member countries achieve financial stability and sustainable economic growth’ (IMF, 2005b).
IMF surveillance takes the form of ‘Article IV consultations’, which usu- ally take place once a year. IMF staff visit the member country to gather information and hold discussions with government and central bank officials, and often private investors and labour representatives, members of parliament and civil society organisations.
In recent years, surveillance has become more transparent than was previ- ously the case. Ninety per cent of member countries now agree to publication of a Public Information Notice (PIN), which summarises the staff’s and the Board’s views, and 80% to publication of the staff report itself.
Today, IMF surveillance covers the following areas:5
1 Exchange rate, monetary and fiscal policy issues. In this area, ‘the IMF provides advice on issues ranging from the choice of exchange rate regime to ensuring consistency between the regime and fiscal and monetary policies’.
2 Financial sector issues. In 1999, the IMF and the World Bank created a joint Financial Sector Assessment Program (FSAP) to assess the strengths and weaknesses of countries’ financial sectors; and FSAP find- ings provide important inputs into surveillance. This initiative was a dir- ect result of the Asian financial crisis of 1997/8, which led to a greater understanding of the role that the financial sector can play in building up vulnerabilities to crisis and to transmitting the effects through the economy.
3 Assessment of risks and vulnerabilities from capital flows have become much more important in recent years. Again, this is a direct result of the increased incidence and severity of financial crises, as detailed in Chapter 7.
That is, the IMF has always been concerned with financial crises, but the attention paid to this issue has increased in tandem with the scale of the problem.
4 Institutional and structural issues. As with surveillance of the financial sector, the role of institutional issues (e.g. central bank independence, financial sector regulation, corporate governance and policy transpar- ency and accountability) as well as structural policies (e.g. trade policy, labour market and energy policy) have also gained importance in the wake of financial crises and in the context of some member countries’
transition from planned to market economies. In this regard:
The IMF and World Bank play a central role in developing, implement- ing, and assessing internationally recognized standards and codes in areas crucial to the efficient functioning of a modern economy such as central bank independence, financial sector regulation, and policy transparency and accountability.
While the BWIs have been the major players in the development of codes and standards (C&Ss), as well as assessing the extent to which they are being met in developing countries, the body charged with setting C&Ss is the Financial Stability Forum (FSF), which was also established in 1999. The FSF has promulgated twelve key standards in areas ranging from economic policy transparency, corporate governance, accounting and banking regulation, but each of these categories contains a much larger number of detailed ‘recommendations’. As is discussed in some detail in Box 8.1 below, critics have argued that the C&S approach is inherently asymmetrical, as it places the responsibility for global financial stability and the elimination of crisis vulnerability squarely with developing countries, ignoring the role that the developed countries play in this process. Furthermore, as has been discussed in previous chapters, it is rarely the case that standards that have evolved to be appropriate for developed markets can simply be transplanted wholesale into a developing country situation.
Box 8.1 Codes and standards and the Financial Stability Forum (FSF)
In the aftermath of the Asian crisis there was a strong sense that ‘some- thing should be done’. Despite the differences of opinion on the pri- mary causes of the crisis, there was a sense that economic and financial weaknesses in the domestic economies of affected countries, as well as shortcomings in financial regulation and supervision, had played a part in the onset of the crisis. Importantly, as well as the objective condition of these variables, the view was that greater transparency was needed.
As we have seen, financial markets work on the basis of information and – in principle – should therefore be able to perform their theoretical functions well to the extent that this information is accurate.
In February 1999 Finance Ministers of the G7 agreed the establish- ment of the Financial Stability Forum (FSF), and the FSF was charged with promulgating international codes and standards (C&S) to estab- lish a benchmark for best practice in areas thought to be of most importance.
Codes & Standards
1. Macroeconomic policy and data transparency
C&Ss under this heading cover: monetary and financial policy trans- parency; fiscal policy transparency; and data dissemination, with the benchmarks in each case being the codes of ‘good practice’ issued on these subjects by the IMF.
2. Institutional and market infrastructure
C&Ss under this heading cover: insolvency procedures; corporate gov- ernance; accounting and auditing; payment and settlement systems;
and money laundering. The respective codes of best practice are those issued by: the World Bank; OECD; IASC; IFAC; CPSS; FATF.
3. Financial regulation and supervision
C&Ss under this heading cover: banking supervision; securities regu- lation; and insurance supervision. Issuing bodies for best practice are:
BCBS; IOSCO; IAIS.
Within these three headings there are more than sixty specific standards, which are seen as reflecting international best practice. Following the promulgation of these C&Ss, the IMF established a review system – Reports on the Observation of Standards and Codes (ROSCs) – which countries could voluntarily agree to participate in. The ROSC process has also become intertwined with the IMF/World Bank Financial Sec- tor Assessment Programs (FSAPs). ROSCs have focused on emerging and developing countries – it is generally assumed that developed econ- omies are compliant, though as Schneider (2003) points out this is far from being the case in many instances.
While most people would support the idea of spreading international best practice in these important areas, the C&Ss have come in for con- siderable criticism:
• First, it is not clear what they are actually for. The impetus behind the C&S initiative was to reduce the potential for major financial crises, yet the level of detail in some cases goes well beyond what most would consider essential in this respect.
• Second, if the aim is to reduce the potential for crises many critics have highlighted the asymmetric nature of C&Ss. That is, while deficiencies in crisis-affected countries certainly play a part in the onset of crises, many have pointed to the influence of the sources of
speculation (highly leveraged hedge funds in developed markets, for example) as well as the highly volatile nature of the international financial system. In the way they are currently organised, the assumption seems to be that crises are entirely and solely the fault of the countries affected.
• Third, as is clear from the bodies which issue codes of best practice in each area, the process is generally an extension of how these have evolved in developed markets, and particularly in the United States.
As Honohan and Stiglitz (2001) have argued, the financial sectors and institutional capacity in many developing countries are such that introducing models of financial regulation and supervision used in very developed financial systems may be ineffectual and even counterproductive.
• Finally, despite their breadth and depth, do C&Ss capture what they are supposed to? For example, prior to the default on its inter- national debt, Argentina received a glowing report regarding its implementation of C&Ss.
As well as these changes to its surveillance activities, the IMF has, as we saw in Chapter 7, moved away from providing short-term financing to support members’ balance of payments stability, to providing longer-term funds through a variety of funding facilities, and to imposing (or negotiating) various policy conditions attached to this lending.
However, as we shall see later in this chapter, critics argue that the Fund’s role has developed in an ad hoc manner, lacking strategic direction, so that today it does many things that it should not, and does not do some things that it should.
8.1.2 The World Bank
As was the case with the IMF, the United States was an important player in the establishment of the IBRD, later to be known as the World Bank. How- ever, unlike the Fund, the eventual structure of which was something of a compromise between the US and UK, the IBRD was almost entirely devised by the US in all its important respects.
Although the Bretton Woods institutions were formally a part of the United Nations system, there were important differences from the outset, and those differences largely remain. In particular, while the UN General Assembly operates a ‘one member one vote’ system, the Bretton Woods institutions are structured more like a private company, where members receive ‘shares’ in proportion to the funds they put into the institutions, with the size of these contributions being proportional to each member’s status in the world econ- omy. As with a private company, the proportion of ‘shares’ that each member
holds is translated into ‘shares’, so that the largest economies become the largest shareholders with the largest voting rights.
In the previous section we saw how this structure has led to the IMF being increasingly dominated by its largest members, and the same is true for the World Bank. For example, at its foundation, the USA received 35.07% of the voting rights in the World Bank, with the UK being the second largest shareholder with 14.52% – together they therefore controlled almost 50% of the voting rights within the World Bank.
However, at its foundation, major decisions taken by the World Bank board required an 80% majority to pass. Uniquely, therefore, this gave the US an effective veto over policy, ensuring that only policies of which it approved were given serious consideration.
Over time the number of countries that are shareholders in the World Bank has increased, which has led to a dilution of the voting power of the founding members. For example, by the mid-1960s, the US’s shareholding had fallen to around 25%, but this still gave it a power of veto. In 1987, however, a major reallocation of voting rights saw Japan granted additional shares – in reflec- tion of its status in the global economy – with the US’s shareholding falling to a little over 16%. An end to the veto then? Not really. In exchange for this dilution, the US raised the threshold on majority decision making from 80%
to 85%, thus retaining its veto and therefore its firm grip on World Bank policy. This grip, of course, has also been supported by the fact that the President of the World Bank is ‘nominated’ (though never then rejected) by the US President and must be a US citizen – as a quid pro quo the head of the IMF is always a European, originally agreed by the European powers, and more recently by the European Union.
For many, this state of affairs has enabled the developed economies, par- ticularly the US, to dominate the IMF and World Bank, which has led to the marginalisation of the UN, which could not be controlled in the same way.
Indeed, at the inception of the Bretton Woods system, Keynes had argued strongly that the IMF and World Bank should be located in New York, to maintain close links with the UN, and avoid being overly influenced by poli- tical institutions based in Washington.6 Henry Morgenthau – the US Treasury Secretary – insisted that the institutions should be based in Washington, however, and so they were and so they remain.
Although the size of shareholdings in the World Bank were determined by each country’s ‘subscribed capital’, only 20% of this capital was ever actually paid to the Bank, with the remaining 80% remaining ‘callable’ if required. In effect, this capital guaranteed the operations of the Bank.
The Bank was (and is) permitted to lend up to 100% of its subscribed capital, with the conditions for lending set out in Article III of its constitution:
1 The recipient government must fully guarantee interest payments and repayment of the principal.
2 Borrowers must be creditworthy.