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Ethos Perspectives
The Future of International Financial
Institutions
Overview
The International Monetary Fund (IMF) and World Bank were
both established at Bretton Woods in 1944 to manage the post-war
international economic system. The IMF was set up to maintain
the international system of fixed exchange rates and to assist
countries with balance of payments difficulties, while the
World Bank’s original mandate was to help countries
in their postwar reconstruction. Over time, both the roles
of the IMF and the World Bank have evolved significantly as
a result of dramatic changes in the global economic environment.
These global changes have raised questions over the continued
relevance of the two financial institutions. This issue of
Ethos Perspectives surfaces some of the main criticisms of
the two institutions as well as proposals for reform.
The Bretton Woods international monetary
system was based on exchange rates pegged to the US dollar,
which was then backed up by gold reserves. However, the US
balance of payments position deteriorated sharply in the 1960s
due to huge military expenditure on the Vietnam War and high
inflation. Consequently, in 1971, the US suspended the convertibility
of US dollars to gold and this led to the collapse of the
Bretton Woods agreement. Since then, all countries have established
their own exchange rate systems, ranging from currency pegs
to managed floats and freely floating exchange rates.
The 1980s and 1990s saw substantial increases
in the volume of cross-border financial flows as economies
liberalised their capital accounts and capital markets became
more integrated. The vast and rapid movements of capital across
borders, combined with often weak financial systems, led in
many cases to banking and financial crises, most notably the
Latin American debt crisis of the 1980s, the Mexican crisis
of 1994, the Asian financial crisis in 1997, Russia and Brazil
in 1998, and Argentina and Turkey in 2001. The IMF’s
interventions in these crises met with mixed results, resulting
in strong criticism of the IMF for acting too late and doing
too little.
As a result of the increased volatility
of global financial markets, the IMF has placed greater emphasis
on surveillance (crisis prevention rather than crisis resolution)
and on developing sound banking and financial systems (as
opposed to just focusing on macroeconomic fundamentals). More
recently, the growing foreign reserves of emerging economies—particularly
the East Asian economies—have raised questions as to
whether the IMF’s role as “lender of last resort”
for crisis-stricken countries remains relevant. Indeed, to
a large extent, the accumulation of vast amounts of foreign
reserves by most of the regional economies scarred by the
East Asian financial crisis reflects a deep distrust of the
IMF and its capacity to respond effectively in a crisis.
Reference 1 is a paper by the US Treasury’s
Undersecretary of International Affairs Timothy Adams. Adams
sets out five priorities in the reform of the IMF, one of
which is to ensure that every member’s voting power
reflects its weight in the world economy. In Reference 2,
Edwin Truman illustrates how this can be achieved through
rearrangement of IMF Executive Board chairs and quota shares.
Michael Mussa, in Reference 3, explains the need for IMF to
restrict its usage of general resources (from the quotas of
members) to the resolution of balance of payments crises and
to act as an “international lender of final resort”.
While the IMF has had to redefine its mission
over the years, the World Bank has seen a significant expansion
of its development mandate in the postwar years. Despite the
expansion of its role, the World Bank’s debt, aid and
trade scorecard has yielded mixed results. The World Bank
hopes to a do a better job by adopting a strategy of good
governance and anti-corruption in partner countries. In addition,
the World Bank recognises that fair voice and participation
of member countries and partners are crucial to the effectiveness
and credibility of its programmes.
Finally, we highlight two articles by former
employees of the World Bank. Reference 4 by Jessica Einhorn,
a former managing director of the World Bank, makes the case
for the World Bank to rationalise its current over-ambitious
agenda. Another former employee of the World Bank, William
Easterly, argues that the grand programmes and the one-size-fits-all
strategies of the Bank are ineffective in addressing poverty
and the developmental needs of poor countries. Instead, he
argues for a “search and discover” approach, emphasising
that policy recommendations should be tailored to the unique
circumstances of each country.
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