Clear-out time for IMF, World Bank
By Hossein Askari
In 1944, as the end of World War 11 was coming into view and in the aftermath
of financial disorder following the Great Depression, the two Bretton Woods
institutions, the World Bank and the International Monetary Fund (IMF), were
created. The World Bank was mandated with financing the reconstruction of
Europe and with long-term economic development projects in developing
countries; the IMF was mandated to be the guardian of international monetary
stability.
However, over the years, both institutions deviated significantly from their
respective mandates to become politicized, over-ambitious and grasping all
decision-making in countries that fell in dire need of their resources. In the
process, they have outgrown
their size, become inefficient and have lost control of their own affairs.
They now duplicate each other to a point that many ministers of finance and
heads of central banks do not know the difference between the World Bank and
the IMF. As a result, a number of academics and politicians have called for the
fusion of the two institutions. Both institutions have incurred financial
losses: the World Bank had to downsize in the 1980s, and the IMF had to do so
recently. Both institutions have also played havoc with the development process
of many developing countries, pushing them deep into debt and economic decline
for a number of years.
As the world economy has been recently shaken by unprecedented financial, food
and energy crises, resulting in the socialization of the financial system of
many advanced countries, the media, politicians and academics have naturally
wondered whether the two Bretton Woods institutions have carried out their
mandates efficiently. Unfortunately, the performance record of both
institutions has been deeply disappointing.
Both institutions have been criticized by many leading figures for their
ill-designed policies. Over more than three decades, the World Bank has
concentrated on policy lending in privatization, demobilization of armies and
downsizing of countries' civil services, while neglecting agriculture
development in many potentially agriculture rich countries as well as
infrastructure. Such diminished emphasis on agriculture has undermined food
security in many developing countries facing rapid population growth.
The IMF has over the past decade renounced its monetary role. Dominated by
political slogans, it has portrayed itself, instead, as a poverty fighter. Both
institutions wanted to promote good governance and fight corruption in Africa,
as if corruption existed only in Africa and nowhere else. Although fighting
corruption has no clear or measurable meaning, most likely turning humans into
angels, such demagoguery shows how far removed both institutions have been
diverted from their Bretton Woods mandates.
While intransigent and dictating policies to developing countries, the IMF has
always been congratulatory of US policies. Staunchly supporting former Federal
Reserve chairman Alan Greenspan's bailing out of hedge funds and excessive
monetary and deregulation policies, the IMF has urged the European Central Bank
to lower interest rates and pursue the same policy stance as the US Fed. In
contradiction with its mandate to stabilize exchange rates as well as take an
orthodox monetary approach to the balance of payments, the IMF was strongly,
and at the same time wrongly, supportive of a deep depreciation of the US
dollar through very low interest rates, as called for in its past World
Economic Outlook documents, to solve external imbalances.
Of the Group of 20 meeting in Kleinmond, South Africa, in 2007, Reuters
reported "The view of the IMF is that the move in the dollar depreciation is in
the correct direction," Evidently, fast depreciation of the dollar contributed
to an acceleration of commodity price inflation, food riots and crippling
energy prices. As a result of the explosion of food and energy prices, real
incomes have fallen sharply, economic growth has slowed and unemployment has
started to rise.
Unlike natural disasters (such as floods, tsunamis and earthquakes) that cannot
be predicted, financial crisis have never been random events. They were fully
documented by classical economists in the 19th century and were shown to be an
unavoidable result of speculative credit boom. Irving Fisher (1933) ruled out
all causes for a financial crisis except a sustained speculative credit boom
and over-indebtedness. Did the IMF predict the present financial crisis when it
was in the stage of incubation? No.
Even after the financial crisis broke in August 2007, the IMF continued to be
supportive of present Federal Reserve chairman Ben Bernanke's aggressive
monetary policy, which has precipitated economic recession and downfall of
giant financial institutions. Recently, the IMF has fully endorsed gigantic
bailouts proposed by US Treasury Secretary Henry Paulson and European
authorities and socialization of the banking sector, without explaining reasons
for such endorsements and their economic, financial, and social implications.
While Bernanke has recently confessed to the US Congress concerning the failure
of monetary policy and suggested a stimulus program to cope with recession, the
IMF has remained in a passive position. There is no plan that can be
authentically called an IMF plan put forward by IMF for dealing with the
financial crisis.
The world community cannot afford two big institutions being the vested
interest of highly paid officials and failing to achieve their basic mandates.
World leaders should consider reshaping these two institutions according to the
type of organization they were in the 1950s and 1960s.
A major cause of the present crisis is that financial institutions refuse to
deal with their basic mandates and want to extend their role to areas that do
not fall under their jurisdiction. In this respect, central banks in many
countries, most notably the US Federal Reserve, do not want to manage liquidity
and regulate the banking system; instead, they want to promote full employment
and growth, based on the Taylor rule (which stipulates how nominal interest
rates should be changed in response to divergences of actual GDP from potential
GDP and divergences of actual rates of inflation from a target rate of
inflation) or inflation targeting.
Similarly, the IMF does not want to deal with monetary issues; it wants to
fight poverty and corruption. In doing so, it has recruited anthropologists and
social workers and has lost over the years its monetary know-how, as new
generations of staff are no longer familiar with IMF practices as they existed.
The World Bank does not want to specialize in financing growth projects; it
wants to promote democracy, fight corruption and promote good governance and
civil society.
Both institutions have been advocating reform in member countries; now, they
have to admit that they themselves need reform. The IMF should remodel itself
into the organization it was in the 1950s and 1960s, basically deleting its
poverty, social and structural mission, and closing its resident representative
missions that number over 90 in developing countries. It is clear that more
than a decade since the IMF decided to fight poverty in Africa, it has
impoverished itself by going deeply into the red and has only increased poverty
and destabilized a number of African countries.
Often, the IMF was told that poverty reduction was the prerogative of the World
Bank and a large number of regional development banks. Yet, the IMF never
accepted this truth and kept on insisting on its poverty fighter role. Its
poverty reduction and growth facility (PRGF) amounts to a pure budgetary loan
disbursed every six months to a country to finance pure government
expenditures, namely large increments in salaries of the army and civil
service. Such use of IMF money makes a country indefinitely dependent on the
IMF to meet its military and civil service salaries. The PRGF resources and the
huge operational costs for running PRGF programs should instead be added to the
resources of regional development banks and finance only development projects
(such as in health, infrastructure, education, agriculture, energy and so
forth).
The world needs an IMF that is in charge of macroeconomic policies, namely
fiscal, monetary and exchange rate policies, leaving trade policies to the
World Trade Organization and economic development and its financing to the
World Bank. The IMF has to deploy its resources and recruit experts in central
banking and in the financial sector, and put in place programs for rebuilding
sound and safe banking sectors in every member country, most importantly in
major industrial countries. The IMF has a long way to go to fill up the
regulatory gap in the financial sector, banking, securities, and futures and
derivatives. It should not underestimate this important task.
The IMF has to be a lender of last resort only to central banks, or monetary
authorities, of a country, using one facility for all countries, and on a
temporary basis. Keeping a country for several years under a program will be
totally damaging to the country as the country cannot regain control of its
economic development policies and will remain forever under an IMF program.
Gold used to be an anchor for central bank's issuance, and used to be, par
excellence, the settlement means for international balances that cannot be
settled with securities and claims. Now, we have an environment with a fiat
money (paper) standard with flexible exchange rates. The IMF has to control
monetary and credit aggregates in such an environment in order to establish
monetary stability. For each country, the IMF should establish a benchmark
monetary program against which monetary performance can be evaluated
periodically. Such an indicative monetary program should be consonant with
exchange rate and price stability and external sector viability.
The IMF should monitor credit aggregates by sector and by maturities, and
regularly evaluate the soundness of the banking system. Fast expansion of
credit can only fuel speculation and deteriorate creditworthiness in a country
and lead to a financial crisis when profits starts diminishing rapidly.
Distorted maturities can be a cause of instability.
The IMF should discourage factor and product-price distortions. Most
importantly, the IMF should discourage the use of interest rates as a policy
tool, as this instrument has turned out to cause instability, distort prices
and create a highly unpredictable monetary framework.
The World Bank should concentrate on fighting poverty and speeding up economic
growth in developing countries. It has to channel International Development
Association resources (low-cost funding for poorer countries) unconditionally
to eligible countries and direct these resources only to long-disbursing
development projects and not to quick-disbursing budgetary aid. The poorer
countries need much more funding for health, education and infrastructure and
for private-sector growth.
World governments should also understand better the mandates of the Bretton
Woods institutions. Such understanding would help both institutions remain
confined to their true mandates.
In recent days, the major concern with both of these institutions has been the
unfolding sex scandal involving the head of the IMF, managing director
Dominique Strauss-Kahn. The IMF board at the weekend cleared Strauss-Kahn of
harassment, favoritism and abuse of power after it hired a Washington DC law
firm to investigate his affair with an IMF economist. The board's statement on
October 25 nevertheless noted that "the incident was regrettable and reflected
a serious error of judgment on the part of the managing director".
That scandal followed on the heels of another involving the former head of the
World Bank (resulting in his resignation). And in the past, rumors have been
rife throughout the institution about impropriety on the part of board members
themselves. These institutions are in need of serious management overhaul.
At the same time, the management of these institutions is dominated by the US,
a handful of European countries and Japan. While the institutions preach good
governance and management, they have been unable to adapt themselves. China is
arguably the most important economic power in the world after the United
States. Yet Britain and France dwarf its influence. Latin Americans are
similarly under-represented. The list goes on.
Will the present financial crisis shake up the Bretton Woods institutions and
make them rise up to the challenges facing the world economy? This will be
answered in the months to come. Nonetheless, drifting further away from initial
Bretton Woods mandates and not improving their management will be costly for
the world economy. Resources will be squandered. Frustration among politicians
and bankers will increase. There have already been calls in many quarters and
reputable newspapers (such as London's Financial Times) for a world central
bank to take charge of world monetary affairs and stabilize financial markets.
It's time to act ahead of the curve.
Hossein Askari is professor of international business and international
affairs at George Washington University.
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