Strengthening Surveillance and the International Monetary System

The effectiveness of IMF surveillance, especially with regard to the functioning of the international monetary system, was a recurring theme throughout the anniversary year. The range of views on this topic had been clearly illustrated at the Institute for International Economics conference in Washington. On one side was a proposal by John Williamson and Randall Henning, which called on the large industrial countries to accept a “blueprint” for coordinating monetary and fiscal policies in a medium-term, IMF-monitored, framework, to stabilize exchange rates and reduce current account imbalances.³ Although the proposal was praised by many participants at that conference for its intellectual underpinnings, it failed to generate any political support. Lawrence Summers, the U.S. Under Secretary of the Treasury for International Affairs, characterized the proposal as “unrealistic” and concluded that there was “little prospect” of its implementation (Kenen, 1994, p. 423). The late Horst Schulmann—President of the Landeszentral Bank in Hesse, Germany—opposed any effort, “formal or informal,” to keep exchange rates within specified ranges, arguing that flexible exchange rates serve as a safety valve when countries are affected differently by circumstances. In these conditions, he concluded, it “has become more difficult to argue that we need the IMF.”⁴

By the time of the Madrid conference, a consensus began to emerge, well inside the extremes: neither laissez-faire nor dirigiste, but aimed at achieving what Maria Schaumayer called “flexible stability” (Chapter 11). In the course of the two days of meetings, several speakers advocated moving toward a target zone system or some other formalization of exchange rate rules or procedures, though they differed both in motivation and detail:

• C. Fred Bergsten (Chapter 3) set aside the ambitious coordination scheme that he had advocated earlier in favor of a more modest proposal for stabilizing exchange rates. He argued that the major countries will not adopt better macroeconomic policies without the discipline of an exchange rate rule, and he concluded that the Fund should become “the steward” of a system of target zones.

• Peter Kenen (Chapter 5) championed the approach of the Bretton Woods Commission, arguing that better policies have to precede systemic reform but also that the goal of exchange rate stability can provide a beacon for those trying to implement better policies.

• Jacques de Larosière (Chapter 10) also backed the Commission’s approach. He argued that the Fund should oversee both the convergence criteria in the first stage (while policies are being strengthened) and the exchange rate bands in the second stage. This role should be part of a more general restoration of the Fund’s “mandate to be the global monetary authority.”

• Paul Volcker (Chapter 12) contended that improvements in fiscal policy would have to precede any effort to stabilize exchange rates, but he also argued that policies could not be coordinated effectively unless exchange rates were the central focus. Thus Kenen, de Larosière, and Volcker all agreed with Bergsten that exchange rates should be stabilized and that steadier and more prudent policies were the means of achieving that goal, but each differed slightly in his assessment of the sequence of steps for getting there. Volcker concluded that the Fund should identify ranges outside which exchange rates would be considered to be misaligned, and that countries should then make a general commitment to manage policies to prevent such a misalignment.

• Several speakers from developing countries, including M. Saifur Rahman, Moeen Qureshi, and Kwesi Botchwey, called for the Fund to find a better means of promoting stable macroeconomic policies in the large industrial countries. Qureshi tempered that point, however, by concluding that developing countries should worry less about stability in the large countries (which they can do little to influence anyway) and more about their own policies. Ariel Buira supported Bergsten’s view that floating has weakened fiscal discipline.

• Stanley Fischer and Michael Bruno questioned the view that target zones would provide any real incentive for improving macroeconomic policies, but Fischer concluded that a target zone system might nonetheless provide a “slight improvement” over the present system if it could help avoid major misalignments such as the overvaluation of the U.S. dollar in the mid-1980s.

The most thorough skepticism about target zones for exchange rates came from Wendy Dobson, on two grounds (Chapter 11). First, she argued that the Group of Seven major industrial countries are incapable of coordinating policies, because officials of those countries disagree among themselves both on the strategy for stabilizing exchange rates and on the analytical linkages between policies and economic performance. Second, in her view the weight of empirical evidence does not suggest that either volatility or even misalignment of exchange rates is especially costly. The only feasible anchor in today’s world, she concluded, is “prudent policies.” Lamberto Dini (Chapter 3) and Jacob Frenkel (Chapter 11) were also skeptical, though they did not go so far as Dobson. Dini warned against attempting to “subordinate … domestic policy objectives to the pursuit of stable exchange rates” or setting “overly ambitious targets,” while Frenkel cautioned that no system could guarantee good performance; officials would have to “earn” good performance through good policymaking.

In any event, skepticism about target zones for exchange rates did not imply skepticism about the role of Fund surveillance. Several speakers, including Bergsten, Dobson, and Toyoo Gyohten, appealed to the major countries to ensure that participation in the process “be as senior as possible” (Gyohten, Chapter 11) so that it could have the maximum possible impact.

Economic Reform and Conditionality

A recurring theme in Madrid was the recognition that the Bretton Woods institutions could take some credit for the emerging consensus on the need for reform in economic policies and that their role in providing policy advice was important. Attention focused heavily on the nature both of their advice in relation to the design of adjustment programs (in developing as well as in transition countries) and of World Bank and Fund conditionality.

Tony Killick led off the discussion (Chapter 8) by posing a paradox. The types of reform policies generally advocated by the two institutions appeared to be responsible for the significant improvement in economic performance of many countries. Yet the direct economic results of specific measures contained in structural adjustment programs supported by the two institutions were “patchy, at best.” Programs appeared to strengthen the balance of payments but not to promote either price stability or growth. Killick explained this paradox in part by what he regarded as a tendency by the Fund and the Bank to view adjustment as “catharsis” rather than “continuous adaptation.” This tendency led to programs that were too narrowly conceived and too short term and that gave insufficient emphasis to such factors as creating human skills, strengthening technological capabilities, and promoting institutional development.

In the subsequent discussion (Chapter 8), Manuel Guitián maintained that the Fund does view adjustment as a continuous process and accordingly conducts a regular dialogue on policies with member countries. Ishrat Hussain felt that the distinction between adjustment as a transition and adjustment as a continuous adaptation was better understood if one allowed for the large variations in initial conditions. Countries that had delayed adjustment and had therefore suffered serious distortions and large fiscal deficits inevitably needed large and fundamental policy changes. Once those changes had been made, it was easier to pursue a continuous adaptation approach to adjustment. Buira argued that the short-term view was driven by the constraint on external funding for adjustment programs. Longer-term programs required more funding, a view shared by Manmohan Singh (Chapter 3).

Killick’s second explanation for his paradox was the “overuse of conditionality” by the Fund and the World Bank. Excessive conditionality, in his view, tended to undermine local “ownership” or endorsement of programs, a quality that Bank studies had shown to have a strong positive correlation with successful outcomes. Killick’s view on this point was shared by a number of speakers. Rahman (Chapter 2) argued that successful external support for development involved “moving at the pace of the people” by responding to the needs of the population, reflecting the degree of conviction that was present, and designing programs in a manner that seemed equitable to the people concerned. Supporting the view that adjustment programs needed to be seen to be home-grown to be fully acceptable, Qureshi (Chapter 12) recounted that he had been able to take tough measures as Prime Minister of Pakistan, particularly in the governance area, because those measures had not been taken at the behest of the Bank or the Fund.

Liu Zhongli argued that the World Bank and the Fund had a positive role to play in supporting reforms, as long as the institutions respected member countries’ decision making and took into account each country’s situation and needs (Chapter 6). Botchwey (Chapter 12), while agreeing with this view, pointed to the danger that the “perfectly agreeable aphorism” relating to home-grown programs was likely to be “intoned by the parties as they walk to the negotiating table, like an incantation, designed—as most incantations are—to free them from the tedious obligation of thinking through what they are saying.” To him, ownership meant that the authorities see the program objectives as being fully consistent with their own objectives, and as something they need to do on their own, and “not as some imposition that they must accept because they ‘need the money’ and have no other choice.”

It is this latter phenomenon that Killick described as “paper conditionality”: programs that all parties recognize will not be implemented and that merely satisfy the need to “keep the money moving,” thus undoing the credibility of the process. He suggested that the Bank and the Fund should be willing to say “no” more often to governments with a weak commitment to reform, and he saw as a minimum test of commitment the willingness of governments to draft letters of intent or letters of development policy, which should never be prepared by staff in Washington. This would enable the institutions to reallocate funds to countries that were seriously pursuing reforms. Botchwey also expressed his dissatisfaction with the way conditionality worked. He argued that where conditionality had not been met, one should not automatically blame the lack of political will; rather, there should be a careful evaluation of the causes of the problem, and waivers should be granted whenever circumstances warrant.

Alassane Ouattara acknowledged the danger of approving paper programs, but he maintained that ownership was not a sufficient safeguard (Chapter 8). It was important to understand local conditions, the political process, and what could reasonably be expected from low-paid civil servants. Issues of governance were also critical. It was important, he argued, to make sure that the public understood the problems and why the measures were needed. He also pointed to the difficulties facing those adjusting countries with high internal and external debt.

The issues raised by Ouattara found agreement among other speakers. Qureshi contended (Chapter 12) that the World Bank must be prepared to take a strong stand on governance issues and to deny its support to those countries where an unwillingness or inability to improve governance was an obstacle to economic progress. A.W. Clausen noted (Chapter 4) that even the most brilliant idea could not be imposed on a society or culture by mandate. It could be implemented only “by a process of education, example, visible successes, and clear and continual communication.” He felt the world needed success stories—evidence of what could happen if governments adopted the right policies; Chile, Mexico, China, and the Republic of Korea might be good examples even if the “mountain of development” had not been conquered.

Leszek Balcerowicz strongly agreed with Killick that the Bank and the Fund should recognize that their main contribution to successful adjustment was their influence on contemporary thinking about policy (Chapter 12). He felt that in the future the voice of the two institutions would depend less on their financial role and more on recognition of their expertise. There was room for a program of mass economic education financed and launched by these institutions. Similarly, Clausen submitted that the institutions had a role to play in educating political leaders in managing reforms (Chapter 4). Such advice would be an important input into democratic decision making. Rahman proposed that the two institutions should participate in and contribute to the open economic debate in member countries to help develop implementable policies (Chapter 2).

Layeshi Yaker, while agreeing on the need for adjustment, questioned whether the present programs in Africa—which he implied had largely failed—were an adequate framework for adjustment. He advanced an alternate framework (Chapter 8) that would include a resolution of Africa’s debt crisis, trade policies that favored Africa, and a massive international plan for human and technological development. Botchwey, commenting on the “unrelenting gloom” about Africa, wondered “if the African lion is condemned perpetually to lag behind the general advance” (Chapter 12). He believed it was not; there were no iron laws at work. Change or turnaround, he maintained, was not only possible but was already happening in Ghana and other African countries.

Management of the Transition to a Market Economy

The issue of the role of the Bretton Woods institutions in transition economies generated a lively debate. Liu argued (Chapter 6) that the initially low level of development in China and the country’s highly centralized planned economy required a gradualist approach to transition. China’s reforms had been implemented with a balanced combination of short-term and long-term objectives and with proper linkages between reform, development, and stability to ensure irreversibility. The program did not try to crush the old system overnight but chose to move from the periphery to the center, and from the individual to the whole, using a range of short-term objectives as stepping stones to long-term goals. From his perspective, the World Bank and the Fund should give greater consideration to the relationship between efficiency and equity. Reforms should not only improve efficiency of economic activities but also bring benefits to the majority of the people so as to ensure their sustainability.

Richard Portes (Chapter 6), while arguing against the use of labels and pleading for a pragmatic approach to transition, identified three errors in the approach taken to transition: overemphasis on macroeconomic policy, underestimation of the role of state enterprises in the transition period, and neglect of the need to strengthen financial intermediaries. He acknowledged that a country in transition from socialism must begin with a bold enough move to make the change in regime credible, but he maintained that structural reform could take place only gradually over time, and that price stabilization was not a prerequisite for such reform. Portes noted that it was appropriate for the Fund to be preoccupied with financial stability, but he was concerned that the countries were forced to reorient their own priorities to match those of the Fund. What he regarded as the overemphasis on stabilization had come about because “all other aid” was conditional on satisfying the IMF.

Viktor Gerashchenko supported Portes’s warning about trying to do too much all at once and his call for more attention to the need to develop the banking system. Later in the conference (Chapter 12), however, Balcerowicz vigorously refuted a number of Portes’s arguments. Noting that the transition countries could not be treated as a homogeneous group, Balcerowicz averred that calling for less emphasis on stabilization was bad advice. He also warned that too much emphasis on reforms at the microeconomic level could lead to more state intervention.

Sustainable Poverty Reduction

Widjojo Nitisastro (Chapter 9) initiated the discussion on sustainable poverty reduction by describing Indonesia’s successful efforts to reduce poverty He attributed this success to sustained, broadly based, and labor-intensive growth; investment in rural infrastructure and appropriate price incentives for agricultural products; rapid growth of labor-intensive exports; and reduction of the population growth rate. Indonesia’s strong performance had helped it to withstand the large external shocks from the depreciation of the U.S. dollar and the oil price decline in the mid-1980s without significantly affecting the pace of poverty reduction. Lessons from this experience for other countries included the need for strong political commitment to poverty reduction, the need to develop both individual and institutional capacity to fight poverty, and the need for broad-based and equitable growth along with investment in education and health. Industrial countries could help by reducing volatility in exchange rates, ensuring market access, and providing generous debt relief.

Albert Fishlow (Chapter 9) broadly endorsed Widjojo’s analysis on poverty reduction. He stressed the importance of policy in averting income inequality, the two most critical issues being land reform and the development of human capital. He recognized that it was not popular to discuss land reform, but there was no question that a “fairer allocation of this basic asset” can serve as an important stimulant to broad-based development, as demonstrated by both the Latin American experience (in a negative sense) and that of the Republic of Korea and of Taiwan Province of China (in a positive sense). This view was strongly supported by Fazle Hasan Abed, who stressed the importance of destroying the power of the landed elite. Bangladesh, he believed, by not undertaking meaningful land reform, had reduced the access of the disadvantaged section of the population to the opportunities from growth.

In discussing the development of human capital, Fishlow noted the high social returns to be gained from education and that it was the variable that in country after country explained the largest proportion of the variance in income distribution. The effects of investment in nutrition, health, and other social sectors were similar.

Fishlow argued that to the two primary approaches to poverty reduction—market-oriented policies augmented by safety nets and the basic needs approach—a third should be added: reliance on local self-governing institutions and community involvement to improve the material conditions and autonomy of the poor. In this context, decentralization would help reach the poor (a view shared by Rahman, Chapter 2), as would greater reliance on nongovernmental organizations. Abed supported this view (Chapter 9) and noted that governmental neglect had compelled nongovernmental organizations to mobilize and organize the poor. Although governments were often threatened by this reaction, they needed to recognize that nongovernmental organizations were there to supplement and not supplant government programs. He concluded that the World Bank should make these organizations an element in the adjustment process, since they would be effective partners in directing resources to the rural areas, empowering the poor, and democratizing purchasing power.

Finance for Development

The relevance of the financing roles of the Fund and the World Bank in light of the growing importance of private capital flows was a strong undercurrent to the discussion throughout the Madrid conference. Singh argued that although the Fund’s financial role may have become irrelevant for the industrial countries, it remained highly relevant for the vast majority of developing countries and economies in transition. It would take some time for these countries to gain access to the world’s capital markets on reasonable terms. Moreover, although private capital flows had become an important source of finance for developing countries, they were still highly concentrated in a few countries. For all others, “substantial lending by the World Bank will remain essential for many years to come.” Singh did not see any contradiction in the expansion of the World Bank Group and expansion of private sector lending or private investment flows. Rather, he saw these developments as complementary and mutually reinforcing. In this context, he noted with regret that Bank lending had not risen since the early 1980s and that net resource flows had turned negative (Chapter 3). Qureshi also felt that the World Bank Group was in a position to play a major catalytic role by providing partial guarantees and taking small participations in large private investments, thus raising the threshold of confidence and making possible large private capital flows into emerging markets (Chapter 12). Volcker was more skeptical on this issue. There were inherent difficulties in a public bureaucracy lending to private enterprise, and he believed that this dilemma posed problems for the Bank in how it arranged its operations.

There was strong support for a financial role for the World Bank and the Fund in low-income countries (Helleiner, Chapter 5; Botchwey and Balcerowicz, Chapter 12) and on the need for IDA to concentrate attention on the poorest countries (Rahman, Chapter 2). Jean-Claude Milleron (Chapter 13) saw mobilizing resources for development as the overriding challenge facing international organizations.

With respect to the IMF, three issues were raised in this area. First, was an allocation of SDRs an appropriate means of supplementing the existing stock of liquid assets available to member countries? Although there had been no such allocations since 1981, this was still one of the principal policy options being discussed; just two days after the Madrid conference, the Interim Committee was scheduled to consider proposals for a general allocation of SDRs plus a special allocation that would go largely to countries that had joined the Fund since 1981. Hans Tietmeyer (Chapter 10) questioned the appropriateness of a general allocation, warning against what he saw as efforts “to circumvent the economic and political limitations of the global transfer of real resources by ingenious financial engineering.” In contrast, Qureshi (Chapter 12) argued that SDR allocations are an important link between international financial stability and development.

The second issue was equally topical. Shortly before the conference, the Government of the United Kingdom had advanced a proposal for the IMF to sell a portion of its 103 million ounces of gold, to invest the proceeds in interest-bearing securities, and to earmark the income from those investments for relief of the debt burden of low-income countries. Kenneth Clarke (Chapter 12) made a brief case for that proposal and was supported by Helleiner (Chapter 5) and Jo Marie Griesgraber (Chapter 8).

A third idea, stemming from a suggestion put forward by the Managing Director earlier in the year, called for “a fast-disbursing, very short-term facility” to help countries cope with speculative shifts in capital flows. That preliminary suggestion was not formally on the table in Madrid, and Camdessus did not mention it in either of his addresses to the conference. It had, however, been considered at the Cartagena conference and was still an option; accordingly, Helleiner recalled it here (Chapter 5), noting that many analysts in developing countries considered the proposal for such a short-term facility inappropriate and felt that it could absorb too large a portion of available resources.

Governance of the Institutions

The issue of the system of governance of the two institutions was raised by several speakers and was the central theme of Moisés Naím’s presentation (Chapter 5). He noted that previous conferences relating to the Bretton Woods anniversary had concluded that the Fund and the World Bank suffered from the lack of a precisely defined mission. Although the two institutions had “reinvented themselves several times” in response to new challenges, the most recent example of which was the assistance to countries in transition, the “downside of this flexibility” was a “significant dose of strategic ambiguity” and goal congestion. A primary cause of this problem was the pressure that the two institutions faced from influential constituencies regarding their fundamental role.

The role of shareholders in this “blurred mission” was commented on by several speakers. Singh (Chapter 3) noted the tendency among industrial countries to introduce new objectives under pressure from domestic political constituencies. Many of these new concerns were unobjectionable in themselves but taken together had led to a diffused pattern of World Bank lending. Clausen and Qureshi were equally concerned. Clausen felt (Chapter 4) that the tendency of industrial countries to impose their political agenda on the World Bank could be “disastrous in the extreme,” because the true magic of the Bank was its apolitical nature. Qureshi (Chapter 12) argued that in each country the Bank must remain focused on the strategic tasks that will advance its central development role and not pander to political pressures. Lewis T. Preston, in his closing remarks (Chapter 13), responded that this was precisely why selectivity was the first of the Bank’s new guiding principles and agreed with Singh that, for this principle to be applied effectively, “we will need the support of our shareholders.”

Naím, however, contended that while external pressures were important, an equally important factor was the way decision making at the top was organized in the two institutions. Although the system of governance had undoubtedly resulted in organizations with a high level of technical competence, it was still a candidate for attention and reform. He contended that the balance between shareholders and management was fragile. The Governors of the Fund and the Bank tended to be senior ministers in their governments and too busy to devote attention to the two institutions. The boards of Executive Directors suffered from a “ritualized and symbolic decision-making process in which management receives very little strategic direction.” Naím called for reform in the preparation and selection of Executive Directors and for a lower turnover rate. This advice also applied to the President of the World Bank, whose five-year term he saw as too short. Qureshi also questioned the present arrangement whereby “the President of the Bank is always an American and the Managing Director of the Fund is always a European,” arguing that it detracted from the “international character and global legitimacy” of the two institutions. Naím observed that the shareholders continued to behave like “absentee owners,” becoming interested in their collective property only when they realized that it was under great and evident danger, when it was frequently too late to do anything about it. Preston concurred with the need for greater attention from shareholders, arguing that it was in the Bank’s interest for them to play an active role in shaping its future direction.

Some speakers counseled that reform of the Bretton Woods institutions should be pursued within the context of a larger review of the “functioning, role, and coordination of multilateral institutions as a whole” (Solbes, Chapter 13). Following such a review, Solbes suggested, the Bretton Woods institutions would have “a new role in driving and guiding a new concept of global multilateralism with a distribution of political and economic weight quite different from the one that prevailed at Bretton Woods.” Helleiner argued (Chapter 5) that such a review should focus on the entire system of international governance. Later, Qureshi (Chapter 12) seemed to agree, arguing that if the United Nations were to be revitalized and restructured, it would become necessary to re-examine how the Bretton Woods institutions could be realigned with the UN system to form a more dynamic alliance to preserve and promote human security. Helleiner maintained that the review currently being undertaken by the Group of Seven on the multilateral system would carry neither a broad sense of ownership nor real legitimacy, and he suggested instead that a representative intergovernmental review along the lines of the 1972–74 Committee of Twenty be undertaken, or at any rate that there be a much more open and consultative process.

The need to strengthen the Interim and Development Committees was also noted. Bergsten (Chapter 3) offered perhaps the most fully formed vision for institutional reform, especially with respect to the IMF. He would reconstitute the Interim Committee as the Council that had been envisaged in the 1978 Amendment to the Articles of Agreement (“twenty years is enough” for an Interim Committee, he proclaimed at the conference); reconstitute the Executive Board as a board of ministerial deputies, meeting several times a year to deal with major policy issues; and establish a board of Alternate Executive Directors, at the same level as the current Executive Board, to conduct the daily business of the Fund. The Development Committee, however, was seen as having been “ineffective and irrelevant” (Helleiner, Chapter 5).

The dominance of the Group of Seven countries in global economic decision making was another major concern. Dobson (Chapter 11) noted that the group is a relatively effective one but lacks political legitimacy, whereas the Interim Committee is relatively legitimate but largely ineffective. She submitted that the Group of Seven could strengthen its own role if it sought to include major developing countries such as India and China within its ranks. Helleiner (Chapter 5) pressed developing countries to seek more influence within the Interim Committee and predicted that the Fund would support such a move.