CHAPTER 17 From Bretton Woods to the Information Age

Harold James
Published Date:
June 1996
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The general evolution of the international monetary system since the Bretton Woods conference has been a movement away from rules and toward cooperation. Increased information has played the role previously occupied by a legal or quasi-legal framework. This development constitutes the fundamental challenge, and opportunity, faced by international financial institutions, The satisfaction of this demand for the reliable provision of information and analysis will become their principal raison d’être.

The Historical Argument

The construction of the postwar international monetary system came as a result of a general agreement that a repetition of the economic and political nationalism of the 1930s could and should be avoided. The interwar experience had provided a vivid and terrifying demonstration of how the collapse of the economic order could bring political and social fragmentation. In the new order, a commitment to keep stable but adjustable exchange rates would eliminate the temptation to engage in competitive devaluation. Controls on capital movements would eliminate the big speculative flows that had destroyed the exchange rate regime of the interwar period. The essential insight of the new vision was that harmonious interstate relations involved a willingness to agree on the surrender of some aspects of national sovereignty.

The agreements produced at Bretton Woods combined a vision of a liberal world economy with a rule. The rule’s primary purpose was to constrain national economic policies in cases where otherwise the interaction of different national strategies might cause disaster for the world as a whole (in currency policy, competitive devaluations; in trade policy, the application of protectionism). Apart from this, it would preserve the policymaking options (“sovereignty”) of nation-states. At the time of Bretton Woods, a vivid memory of the 1930s saw the requirements of the international order as frequently in conflict with the imperative of building a more just and stable domestic order. The conference aimed at providing a solution to this dilemma. The main attraction of the rule was that it was impersonal and largely automatic. States were obliged under the terms of their legislation accepting Bretton Woods to maintain fixed exchange rates. The pursuit of inappropriate policy would lead to danger signals, in the form of balance of payments imbalances. A state could then either take corrective action (adjustment), if necessary with the assistance of the resource pool created in the IMF; or, if it was judged that the imbalance reflected a fundamental disequilibrium, the exchange rate could be altered with the approval of the Fund. The commitment to keep the exchange rate fixed would by itself provide sufficient limitation of the room for national policy maneuver. A further function of the Fund was to create through the quota mechanism an additional pool of reserves (it functioned analogously to a credit union). The goal was to ensure that, in a period in which outside the United States a general shortage of reserves existed, this limitation would not stand in the way of the movement to liberalized trade and exchange convertibility.

“I seem to be without any small change. Would you accept a ‘Special Drawing Rights’ voucher?”

This system had a strong element of automaticity, but one that would and could never be total. The principle of surveillance by the Fund developed out of the necessity of judging whether a member country’s needs and policy objectives corresponded to a situation in which the use of the Fund’s resources would be appropriate; as well as out of the commitment of members to consult if they maintained the transitional regime (under Article XIV of the Articles of Agreement) in which exchange controls might still be tolerated. In other words, the Fund as a financial institution was required to use its lending to promote a specific outcome. Its resources were to be used “to facilitate the expansion and balanced growth of international trade, and 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.” The Articles also recognized the importance of the new body in the exchange of information and views. Its purposes had already been defined as “to promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems.”

The basic commitment to rule-guided liberalization inherent in the acceptance of convertibility laid the foundations for a system that created unprecedented rates of economic growth and increased prosperity throughout much of the world. However, there were two major surprises. First, the new institution never controlled world liquidity (and indirectly the world money supply) in the way originally envisaged. As the global economy grew, IMF quotas accounted for ever smaller shares of international reserves. Even the new IMF “money” of the 1960s, the SDR, which actually reproduced quite faithfully the intentions of the founders of Bretton Woods, came to represent only a very small part of the world’s reserves. Instead national authorities, and increasingly also the substantially uncontrolled operations of the Euromarkets, created their own money.

The second development, largely unforeseen at Bretton Woods, was one that both contributed greatly to the dynamism of the world economy and also altered the character of the monetary order. This development was the emergence of large capital movements, freeing money from national control. The original agreements had involved an obligation to liberalize current accounts, but—among other considerations—the primary rule (fixed exchange rates) involved the necessity, or at least the possibility, of controlling capital flows. When the world returned after the war to nearly general convertibility at the end of the 1950s, and accepted the corresponding Article (Article VIII) of the Fund’s Articles of Agreement, this meant convertibility on current account only. However, even at this early stage, substantial capital movements developed. The access to resources they brought constituted one of the main incentives to many countries to adopt convertibility. Capital movements brought not just the possibility of increasing national investment levels, they were also often associated with flows of skills and technology. This was true of Spain in the late 1950s, and then of Latin American countries (where the initial experiment in convertibility was often unsuccessful) and East Asia (where some spectacular successes occurred).

As capital flows developed, the problems of monetary management became more complex. One instance of the new difficulties was the effect of capital inflows on the domestic money supply. Another example was that capital flows allowed a financing of current account deficits. Initially, current account deficits were believed to be the major problem requiring international action; but capital flows might make them less of a problem. Inflows—foreign borrowing—could offer an easy and at least temporary alternative to immediate adjustment. Obviously, such flows depend on the verdict of the lenders—the market—and cannot necessarily be maintained indefinitely (particularly if the resources are chiefly used to pay for increased consumption). The availability of capital often simply offered the possibility of making a choice about a time frame for adjustment; but governments (with often limited political time horizons reaching to the next elections) wanted to take advantage of such a choice, and defer the adjustment as a problem to bequeath to their successors. As a result, there were temptations not to recognize underlying economic problems. The new difficulties were the underlying rationale for the extension of IMF consultations to include also the member countries that had gone over to full convertibility under Article VIII of the Articles of Agreement. Such consultations might give advance notice of the likely emergence of economic problems. Throughout the 1960s the international community repeatedly tried to develop a systematic approach to “early warning signs.”

At the same time, the availability of funds on capital markets altered the demand for liquidity. In cases when confidence was maintained, there would be sufficient liquidity as a consequence of private lending. Such funds, however, would not be available exactly when they were needed—in a crisis. In cases where confidence disappeared, the Fund became more necessary than ever as a substitute for the private market, as a way of financing imbalances and restoring expectations of stability: in short, as a reserve center or a lender of last resort. There are two ways of providing such assistance: the first, immediate support in the case of a market panic, in order to forestall an imminent market failure, is undertaken by central banks or (for many industrial countries) by the central bankers’ central bank, the Bank for International Settlements (BIS). The second, in which policy changes as well as a persuasion of financial markets are required to restore confidence, after a market failure has already taken place, has been the domain of the IMF. (The IMF could potentially play a larger role in the former operation also—perhaps not so much directly, by trading on its own account, but by using its resources to help to unwind the substantial swap positions built up by central banks in cases of intervention, when they are not unwound as an immediate consequence of the re-establishment of confidence.)

The flows of capital brought an increasing instability to the system, and eventually destroyed the par value system between 1971 and 1973. As the instability became more apparent in the late 1960s, the transfers of funds across frontiers increased dramatically; once the system was evidently in crisis, between 1971 and 1973, they became even larger. Fixed parities might have survived somewhat longer had it not been for the temptation that a system of rules offered to some of its members to exploit the rules in order to obtain national advantage. Two countries issued the major reserve currencies. For a long time, the system had tolerated the problems of the lesser reserve currency (the British pound) and the constant problems it generated internationally, first in slowing the move to general convertibility, and then in the 1960s in producing repeated balance of payments crises. One of the reasons for the failure systematically to deal with the problem of the pound sterling lay in the U.S. desire to protect the pound out of a sense of solidarity between the reserve currencies. The dollar’s reserve role had insulated the United States from the need to undertake adjustment in the par value system; the result had also generated permanent surpluses in other countries as the counterpart of the American deficits. This U.S. privilege had been a function of the operation of the par value system on the basis of dollar reserves; out when at the end of the 1960s the United States began to view the dollar in the same way as Britain had long treated the pound, as a national resource to be manipulated for the sake of national advantage, the system soon collapsed. Subsequently, other countries chat became major issuers of reserve currencies have been frightened to use (or abuse) the system in this way, and highly conscious that adding to international reserves through the buildup of current account deficits courts the risk of a dramatic and unpleasant reversal of confidence.

A solution to this challenge that maintained the par value system would have involved an earlier and orderly devaluation of the dollar relative to gold and other currencies; but there existed no institutional way of obliging the United States to take such a step, and at the time almost all commentators doubted whether it was possible at all. The strain on the U.S. position increased as the other nonsurplus countries implemented their own devaluations relative to the surplus economies (Germany and Japan), and they at the same time of course had to alter their parity with respect to gold and the dollar. Many members began to see the system as not beneficial, but rather as a mechanism for forcing them to adjust and suffer from the effects of U.S. monetary expansion. This was the basis for an attack on the U.S. “hegemonic” position, or on what General de Gaulle called the “exorbitant privilege.”

One possibility of dealing with the strains was sometimes touted in the 1960s, but fortunately dismissed: an imposition of capital controls. If such controls had been widely adopted, they might have rescued the par value system; but they would have also severely constrained the future development of the world economy. The emergence in the 1950s and 1960s of substantial capital movements through “leads and lags” on the current account had in any case abundantly demonstrated the futility of such control. The desire to halt capital movements, or at least to separate “good” or “productive” from “bad” or “speculative” flows, remained quite powerful, partly because governments wished to prevent markets exercising a vote of confidence on their policies, and partly because the adherents of a fixed rate system saw this control as the only path to realize or preserve their dream.

The search for a new order was extremely painful. The wish to avoid a system of exchange rates too rigidly fixed, which had constituted one of the problems of the 1960s and had helped to propagate inflation internationally, now produced a system whose flexibility verged on anarchy. In the event, the new system removed limitations on national monetary policy, and consequently fanned inflation even further. Thus inflation now came to be seen as a product of an international system of flexible exchange rates, as well as a result of the fixed par values of the classic Bretton Woods system. In other words, inflation appeared as a problem of monetary discipline that might result regardless of the exchange rate regime. At the same time, the differing extent of countries’ willingness to tolerate high levels of inflation produced a sharp divergence in national policy approaches, caused further problems in financing, and provoked doubts about whether the private sector could handle the flows. The coordination problems produced by the pursuit of very different national strategies strained the international order yet further.

The collapse of the Bretton Woods currency rule led to increased temptations to apply protectionism (some writers began to refer to the phenomenon as the “new protectionism”). After the collapse of par values, the world experienced a series of apparently incessant shocks and crises: the dollar shock, then the oil shock, then the inflation shock, then another oil shock, then debt. In the 1980s and 1990s, the dramatic shifts and reversals of economic expectations caused by political events continued with the shocks of the invasion of Kuwait, of German unification, and of the collapse of the Soviet Union. World trade continued in fact to grow in the 1970s and 1980s, although at slower rates. That growth provided a testimony to the vitality of the system, and to the way previous successes had produced a demonstration effect of the virtues of liberalized trade.

In the absence of the “hard law” provided by the rule-based order of the classic Bretton Woods regime, and in the presence of greater possibilities offered by the availability of capital imports, the need for effective surveillance became much greater. This requirement for a working international system was accepted in the new Article IV of the Second Amendment (1978) of the IMF’s Articles of Agreement, which stated the principle of the Fund’s “firm surveillance” over members’ exchange rate policies and also specified (Section 1) that “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.“

Some of the search for effective means of channeling international cooperation, however, took place outside the context of the universal institutions created in Bretton Woods. Since 1945, a large number of institutional mechanisms had been evolved for reconciling the desire for an international economic order with the domestic concerns and priorities of nation-states. Not all of them saw the problems in terms of the requirement of a global system. The most general channels of cooperation were the Bretton Woods institutions, the IMF and the World Bank, but they played only a subordinate role in the first postwar decade. As a result, more specific institutions were required to deal with the immediate postwar problems. The General Agreement on Tariffs and Trade (GATT) was the replacement for the still-burn International Trade Organization (ITO) and would manage trade liberalization by providing a mechanism for negotiating abolitions of trade quotas and tariff reductions, (It would take almost 50 years for the GATT to be transformed into the Wotld Trade Organization, launched on January 1, 1995.) The Organization for European Economic Cooperation (OEEC) would coordinate the process of European economic integration. These institutions proved remarkably successful, and lived on in much modified circumstances. The GATT remained as a crucial forum for trade negotiations, even though the 1970s gave rise to a “new protectionism” in which devices such as voluntary export restraints were instituted with the specific intent of circumventing GATT rules. (In addition, large parts of the world’s trade—agriculture from the beginning, textiles after the 1960s, the trade in services and intellectual property—escaped the rule of the GATT.) The OEEC continued as the Organization for Economic Cooperation and Development (OECD), with general policy coordination tasks for the industrial world. Other groupings also worked hard at the same task: the G-10, and then, later, the G-5 finance ministers (later G-7), the G-7 summit process. The G-10 arose out of the need to supply additional resources in the absence of a large IMF quota increase, and then evolved institutionally as a forum for more general discussion.

With the advent of the G-10, a division of the world institutionally into blocs of “powerful economies” and “developing countries” began. Developing countries produced their own institutional answers to the coordination attempts of the developed world: the United Nations Conference on Trade and Development (Unctad), the G-77 within the UN framework, or the G-24 within the IMF and World Bank setting as a response to the power and influence of the industrialized G-10. The Committee of Twenty, and its successor, the Interim Committee, remained attached to the ideal of global discussion of common economic problems. At a regional level, the proliferation was even more striking: regional free trade associations and multilateral development banks.

The later coordination institutions that followed the Bretton Woods twins arose out of quite particular circumstances: the OEEC to cope with postwar reconstruction, the G-10 to agree to the provision of additional lending for the IMF, the G-5 out of a successful informal discussion group, and the summit as a result of the application of the G-5 principles at the head of state level. A new G-24, composed initially of OECD countries, was created in 1989 as an ad hoc group for the coordination of economic assistance to Central Europe. The successful institutions outlived the circumstances of their birth and developed more general functions. (Perhaps the most striking example of adaptation is the BIS, originally conceived as a depoliticized way of making German reparation transfers after the First World War, but which rapidly became a crucial instrument for central bank cooperation and coordination.) The outcome was a broad spectrum of institutions with rather different origins and histories, but with common and even competing concerns.1 Helmut Schmidt, who was himself responsible for a part of this institutional proliferation, explained that there existed no single world organization that could control a world economic crisis. Instead a “wild growth” of institutions discussed and reflected on economic issues.2 In this dense network, regular meetings between the leading national policymakers and officials became routine, and such close contacts undoubtedly fostered international cooperation. They also sometimes, however, provoked suspicions and misunderstandings.

The Problems

Two problems have dogged this multifold institutionalized cooperation: first, since changes and news of impending alterations offer the controllers of private funds the possibility of making dramatic gains, many market-sensitive policy issues became very hard to discuss and analyze. The more substantial the capital flows, the greater the extent of sensitivity and vulnerability. This was especially true of exchange rates, and of central bank intervention on exchange markets—both in the fixed and in the flexible systems; but it is also true of interest rate policy. Second, strong political pressures and incentives led to an attempt to orchestrate policies in a narrower setting, to create “our small group.”

As regards the first problem, the most remarkable postwar example of the increased difficulty of practical surveillance is perhaps to be found in the contrast between the alacrity with which parity alterations were discussed by the IMF as a tool of policy and a facilitator of adjustment in the late 1940s, and the reluctance of the G-10, the OECD, and the IMF to consider parity alterations for the major currencies in the 1960s. The extreme receptivity of markets to rumor, combined with the political delicacy inevitably associated with issues affecting national prestige, produced what amounted to a tabu on discussion.

There was a fear that grew with the threats to the credibility of the system that any dent would make impossible the attaining of any new stability. In particular, the U.S. unwillingness after the late 1950s to consider a change in the dollar parity of gold, despite balance of payments deficits, produced near paralysis. It led to an institutional incapacity to deal with the needs of the global economic situation. In these circumstances, the only hope for change lay not in additional discussion, but in deliberately obstinate or destructive behavior. The china shop needed a bull, and in the circumstances of 1971 John Connally played that part with considerable verve. One of the major tasks of a reformed system, the IMF’s Executive Board concluded, would be to establish “criteria and procedures for orderly change which will accord to the United States, as well as to other members, a due measure of initiative in the effective exercise of exchange rate flexibility.”3 This story, from the classical Bretton Woods era, of increasing inability to discuss market-sensitive problems was repeated (with different institutional actors) in the story of the European Monetary System (EMS).4 In the early years after the creation of the system in 1979, there were few problems in both discussing and undertaking parity alterations. Later, from the mid-1980s, consideration of parities within the EMS became so politically sensitive, within the European Community, but also consequentially within the OECD and the IMF, that it was in practice ruled out.

This dilemma provides an example of a more general problem, that an institution responsible to member governments finds the discussion of market-sensitive material very hard, as governments may resent the implications of second-guessing the market, and can only be persuaded by arguments about what the market is likely to do after the market has actually done it. For instance, in a different context, it is possible to imagine the outrage if any international institution had given a clear and statistics-laden warning about the extent of bank exposure to middle-income debtors in the summer of 1982 and thereby touched off a panic flight of funds; it needed to wait for the crisis to be triggered by market sentiment. The same consideration would apply to any warning about the increasingly serious overvaluation of the Mexican peso in 1994. Advice about this kind of problem can be given only on the basis of extreme confidentiality.

The second problem that has persistently affected the world economy is that of a too narrow or too partial framework for cooperation. Particularly when global cooperation failed or faltered, states looked to a more limited setting generated by geographic proximity or by common security concerns. The initiatives at European monetary integration in the late 1960s, and again one decade later, began primarily as responses to the problems of the U.S. dollar. Regional or selective forums for cooperation might on occasion have offered an easier way to obtain agreement, but they inevitably found it hard to discuss structural problems affecting the whole of the world economy. They did not necessarily provide a stepping stone for increased global cooperation; sometimes they constituted a diversion.

This lesson appeared repeatedly as part of the story of European monetary integration. Some Europeans saw the creation of a European zone of monetary stability as a way to greater world stability, a bold European initiative that took the place of a failed global effort at stabilization: first there would be an EMS, then negotiations to make the United States de facto a member of the system. This strategy did not work. The difficulty inevitably inherent in partial solutions was also evident in the important and occasionally successful role played by the G-5 or G-7 in fostering world economic cooperation. Not all the world’s balance of payments problems were between the G-7, and, as a result, G-7 negotiations could hardly be expected to produce a solution. Some participants responded to the problem by demanding a return to a smaller framework, a G-5 or even a G-3.

The G-7 summit had begun as a response to the enormous challenge posed by the great economic dislocations of the early 1970s. It had survived in large part because of the mixture of economic and security calculations characteristic of the later stages of the Cold War. During the 1970s, the major economic problems that followed from the oil embargo and the price increases and then from the recycling of petrodollars had been treated, especially in the United States, as primarily a security threat. In the 1980s, major economic issues, such as the construction of a Soviet gas pipeline by West European firms, again were thought of in Washington primarily as the instruments through which superpower rivalry might be conducted. Then, at the end of the Cold War, security problems raised by the collapse of the Soviet empire provided the major theme for summit discussions.

After the end of the Cold War, however, some commentators began to ask more fundamental questions. Who are the seven of the G-7? They are certainly not, as they are most frequently described in newspapers and by many politicians, the world’s seven largest economies. The seven largest in 1993 as measured by GDP, calculated on the basis of purchasing power parity, were the United States, China, Japan, Germany, India, France, and Italy.5 Neither are they the seven most “advanced” economies, if this term is measured in per capita income (for 1990, the seven richest would have been Switzerland, Japan, Norway, Finland, Sweden, the United States, and Denmark).6 Other criteria that might have been used are equally inapplicable. They are nor the seven economies in which the world’s most important financial centers are located. The seven largest stock exchanges, measured by volume of transactions, in 1992 were the United States, Germany, Japan, the United Kingdom, Taiwan Province of China, France, and Korea.7 The closest fit of the G-7 is with the list of the seven leading exporters: in 1991, the United States, Germany, Japan, France, the United Kingdom, Italy, and the Netherlands (in 1975, the list was similar, with only the order of the Netherlands and Italy reversed). Fundamentally, however, the G-7 are composed of some powerful economies, which developed, as a matter of historical chance, into a very powerful institutional grouping. There have been attempts to enlarge the grouping. In the late 1970s, as the oil producers became a major force in the world economy, they asked for representation at world economic summits. In the early 1980s, the Prime Minister of India pressed for the participation of some of the large developing countries. In the early 1990s, some of the G-7 felt embarrassed by the presence but not membership of Soviet or Russian leaders, and argued that Russia should be admitted to the club. There was also some recognition that speaking about economic problems and attempting to produce solutions just within the G-7 was inadequate. Before the 1992 summit, the U.S. Treasury Secretary held separate talks with Latin American finance ministers.8 In 1993, the Indonesian President visited Tokyo before the summit to explain the position of nonaligned countries. But in general, most of the G-7 felt that any enlargement would open a Pandora’s box and would destroy the effectiveness of the process.

The debates about enlargement reflect the highly problematic legacy of a mixing of security and economic concerns characteristic of the 1970s and 1980s. As the U.S. position relative to other noncommunist industrial countries weakened in the course of those decades, it needed to find new ways of implementing its political concerns. In reordering the institutional management of the world economy after the end of the Cold War, it would be both inappropriate and damaging if the mixing of security and economic concerns so characteristic of the previous 40 years were to be continued. This linkage greatly complicated the task of international policy coordination at the highest political levels, and continues to present problems. For example, admitting a few more countries to the G-7 process simply because they are potentially worrying security threats, or because they possess nuclear weapons, is not a rational way of handling the problem of global economic coordination. Such a partial extension would leave out too many important interests and actors in the global economy: the overwhelming majority of developing countries, the newly industrializing economies, and so forth. It is worth recalling that the first attempt to achieve international cooperation in trade as well as in diplomatic affairs, the Amphictyoni Councils held at Delphi, is generally thought to have failed because the councils “were never universal and many important states remained outside.”9

Many new areas have recently emerged in which there is a risk of a confusion of security policy and economic policy, of mixing high politics with the more mundane business of commerce and finance. Making assistance or support dependent on a complex political conditionality (on human rights, for instance, or on military spending) will only politicize the operation of the international economic order. It is true that many countries, including some developing countries, reduce their economic potential by excessive military spending;10 but there are also many wholly legitimate security concerns, and it is equally clear that without adequate protection against external attack, economic development too is threatened. The best way to obtain the economic benefits associated with a reduction in military expenditure is by persuasion, rather than an extension of conditionality. It is also true that a good deal of evidence shows that democratic societies in which human rights are respected, and which enjoy a higher measure of social stability, perform on the whole better economically than controlled societies.11 But processes such as democratization do not lend themselves to the formulation of simple measures or rules, of the kind provided for instance by balance of payments statistics. These kinds of interventions are almost bound to provoke the response that they favor the power interests of a particular group of states. Two highly controversial issues of 1994–95—the economic restructuring of the former Soviet republics and the Mexican peso rescue package—have suffered from overpoliticization to the extent to which they were conducted outside the framework of a clearly understood body of rules, and outside the institutional setting of the IMF. The virtue of the Bretton Woods mechanism was that it created a depoliticized way of dealing with economic issues.

The Chances

An increasingly prevalent view holds that the market alone should do the job of providing information: that the institutional framework of Bretton Woods was highly effective in restoring the world to the near-complete capital mobility that prevailed in the golden years before 1914, but that the fundamental task of rebuilding a liberal, globalized economy has been accomplished. (There may still be some way to go, but a large part of the journey is done.) Many responsibilities are currently being transferred to the private sector, where they are often better handled than by public authorities. In practice, however, governments continue to wish to direct and regulate capital movements in more or less concealed ways—through fiscal measures, regulatory directions, jawboning about the appropriate level of exchange rates. Markets remain liable to faddishness or herd instincts. In consequence, there is still a need for an institution to examine and compare national policies that affect the movement of capital internationally. If in the years after Bretton Woods, the emphasis was primarily on the liberalization of the current account, the period after the breakdown of the par value system saw first increasing debate about the desirability of liberalizing capital flows, and then a need for the effective management of that liberalization. The need arose for international judgments about the use or abuse of capital market liberalization for purposes that might be beneficial to individual participants but could also be collectively harmful.

In this regard, the two problems outlined above appear particularly acute: the difficulty posed to policy discussions by the sensitivity of markets and the volatility of international capital; and the proclivity to look to partial or regional answers to the demand for enhanced cooperation. What answers can be found to these long-standing dilemmas? The first issue—the tabu on discussion of some policy issues—can be at least in part solved by the creation of a common context (of fiscal consolidation and a stability-oriented monetary policy), in which the expectations of the market are stabilized {and markets are as a result less sensitive). If policy is conducted in a longer time horizon, there are fewer abrupt changes to which markets will react violently, or attempt to anticipate. The IMF has consistently insisted on structural reforms and structural adjustments in order to create a stable framework of expectations; including the opening of markets, more flexible domestic product and labor markets, an opening to capital movements, as well as fiscal and monetary behavior conducted in terms of a stable medium-term strategy. The best means of lengthening the time horizon is to mount the cooperation process in as broad a context as possible (thus providing the answer to the second problem, that of partial cooperation). It was an essential part of the vision of Bretton Woods that the institutions created to supervise and channel economic cooperation should be universal. With the end of the Cold War, that promise of universality has at last been virtually fulfilled. The membership of the IMF is now neatly identical with that of the United Nations; and the GATT has also gained members (see Table 17-1).

Table 17-1.Membership of International Organizations
Sources: United Nations, International Monetary Fund, and General Agreement on Tariffs and Trade.Note: Figures have been adjusted to reflect shifts in membership owing to the amalgamation and separation of existing states.
Sources: United Nations, International Monetary Fund, and General Agreement on Tariffs and Trade.Note: Figures have been adjusted to reflect shifts in membership owing to the amalgamation and separation of existing states.

Designing a universal financial institution, however, is not as simple a task as may appear at first sight. As a financial institution, the conduct of the IMF is determined by a set of rules and procedures that distinguish it from other universal institutions, notably the United Nations. The principle of weighted voting, approximately in line with the quotas of members, has always been an essential feature of the Fund’s operations. Voting is in practice not important in the overwhelming majority of decisions made by the Executive Board, which tends to operate rather through the process of discussion and the emergence of consensus. But it is critical in making basic policy decisions, such as the creation of new facilities, or the issue of SDRs. Weighted voting was much criticized, especially in the 1970s, when a highly politicized debate over the shape of international institutions flared up. The advocates of change believed that a one-member one-vote principle, or a transfer of responsibilities to the United Nations General Assembly, or some other body operating a similar voting rule would be more democratic and in particular produce an international financial order more responsive to the concerns and needs of developing countries. The defenders of the existing system pointed out that weighted voting was more appropriate to a financial institution, since votes would result in commitments and obligations that were proportionate to quota size.

These discussions were only an extreme example of the difficulties surrounding any quota-based approach, in which there is necessarily an element of arbitrariness. The basis of the allocation of quotas in the Fund has always been controversial. Even at Bretton Woods, it was the basis of painful tussles between the conference participants. The original formula, devised already in 1943 in the United States, was based on historic figures on national income, foreign reserves, and international trade (in terms both of value and of the variations of exports). In the quota review of 1959, additional consideration was given to the growth of trade; in 1964, a larger range of formulas was used to calculate a quota range. The 1975 quota review began to treat economies for the purpose of quota determination in groups (industrial, more developed primary producers, oil exporters, developing countries). As a result, the quotas calculated under variants of the “Bretton Woods formula” began to diverge from actual quotas. The largest quota holder has always been the United States, but in each successive general review, the U.S. share has been reduced. So too has that of the United Kingdom, which originally had by far the second largest quota. At the same time, since 1959 the quotas for Germany and Japan have been increased, as were the quotas of the large oil producers in the 1975 and 1978 reviews. The quota calculations obviously reflected shifts in the structure of the world economy, but it is not clear that the current quota distribution accurately represents the pattern of economic power.

The Japanese and German quotas in particular are significantly lower than either their share in world trade or their share in international currency transactions (see Figure 17-1). As the issue of a changed or enlarged membership of the Security Council is debated, it is likely that increased representation in the IMF of the second and third largest economies of the world will also become a topic of concern. In the late 1970s, one of the reasons that these quotas were held down involved an explicit penalization for what were felt to be inadequate efforts in the surplus countries to bring about greater global growth.12 The same reasons might be given for an opposite response, an attempt to bind surplus countries and issuers of “key cunencies” more tightly into the framework of responsibility for world economic decision making.

Figure 17-1.IMF Quotas and the World Economy

Sources: International Monetary Fund, and International Monetary Fund, Annual Report, 1992.

The Consensus

Intellectual developments have created a new potential for effectiveness of global institutions. One of the most startling developments of the 1980s and 1990s has been the emergence of a consensus about many economic issues. A great part of the difficulties faced by the makers of Bretton Woods was due to their inability at that time to build on such a consensus. At the outset of the postwar era, no consensus existed on how to deal with the problems of domestic economic management and on how the domestic economy would affect the international order. As a consequence, for most of the postwar period, institutional arrangements were generally strained by the absence of a common agreement or outlook. They were torn by disputes about the advantages of protection, or disrupted by disagreements about the effects of fiscal deficits, or paralyzed by differences about exchange rate policy. Some countries, notably France, had committed themselves to a mixed economy with a sophisticated system of indicative planning and investment allocation. Some, like the United Kingdom, relied on finely tuned macroeconomic management. Others, in particular Japan, eschewed formal planning, but created an extensive system of informal coordination and administrative guidance. Germany, Italy, and the United States followed a much less interventionist course. In many newly independent countries, Soviet-type central planning appeared as a promising way to rapid growth. The IMF’s Articles of Agreement very deliberately protected national sovereignty and allowed states to formulate for themselves their own economic and political interests.

At the outset of the postwar economic miracle, many observers deduced that classical or neoclassical economic theory was bankrupt when it came to dealing with the “real world” of politically motivated behavior. Jacob Viner, for instance, in 1951 wrote that: “The world has changed greatly, and is now a world of planned economies, of state trading, of substantially arbitrary and inflexible national price structures, and of managed instability in exchange rates. The classical theory is not directly relevant for such a world, and it may he that for such a world there is and can be no relevant general theory.”13

The absence of a shared framework for analysis repeatedly proved frustrating. For a time, the Bretton Woods system itself guaranteed a consensus about the international order and the desirability of an international rule, simply because it coincided with, and also helped to produce, spectacular economic growth and widespread prosperity. Gradually national concerns, however, overwhelmed the commitment to the international order. In the 1970s, major international imbalances resulted from differences of view about the appropriate speed of adjustment to the consequences of the oil price shock. When some states adjusted earlier than others, the national differences were often fought out as rival interpretations of what the world economy needed. The quick adjusters (Germany and Japan) thought that the other states were causing international inflation; the latecomers (particularly Italy and the United Kingdom, but on some occasions also the United States) thought that the rapid adjusters were constraining world growth.

The proposition that inflation or permissive monetary and fiscal policies could not represent an adequate way of sustaining high rates of growth was accepted more quickly in the context of national discussions of macroeconomic policy; it was only at the end of the 1970s that it became a widely shared international viewpoint (and then became a common feature of G-7 summit and Interim Committee communiqués). The new insight came in large part because of the economic instability created by the sharp expansion of world money during the 1970s. The IMF played an important part in the discussion of the new problems by consistently arguing that in the case of surplus countries, the need was less for greater fiscal or monetary stimulus than for more far-ranging “structural” measures, including trade opening, greater flexibility in labor markets, and (especially in the 1980s) a greater emphasis on marketization, competition, and privatization.

As late as the first half of the 1980s, major differences in analysis between countries still remained. Leading U.S. policymakers refused to accept the elementary economic proposition that current account imbalances are identical to the national balance between savings and investment and that fiscal policy could as a result be responsible for a fall in saving that needed to be financed through foreign savings. The resulting inflows would explain the rise of the dollar on the foreign exchange markets. These debates were wider in their implication than merely informing Americans why their dollar was like a yo-yo on foreign exchange markets. The discussion raised the issue that had been central to the overall success of the world economy since Bretton Woods.

The initiative for the opening of the world economy after 1945 came largely from one country, the United States, sometimes indirectly through its great influence over international institutions (which was especially strong, and beneficial, in the immediate postwar period), and sometimes directly through its trade policy. When, after the end of the dollar shortage, the United States became worried about the emergence of new surplus countries (first Germany, then Japan, and later the East Asian “tiger” economies), the character of its response inevitably affected the development of international institutions, and also of the world economy. The political argument swung backward and forward: demands for trade restriction and bilateral trade-restricting agreements appeared, the exchange rate policies of the surplus countries were questioned, and the United States wanted to use bilateral (and sometimes also institutional) pressure to force an appreciation of the surplus currencies. If the forces pushing in the other direction rely simply on an appeal to beneficence they can scarcely hope to succeed; many will ask why Americans should make sacrifices to support the world economy. Understanding how measures that lead to a reduction in global trade will hurt national welfare is a hard task: particularly because it runs counter to deeply held beliefs that governments should be activist, “do something,” in the face of an economic difficulty. The temptations to break with the liberal concept of the global economy can only be overcome through an effort at understanding. When surpluses and deficits are understood less in terms of trade performance than as a reflection of different levels of saving and investment, there is a possibility of moving to a debate on how the behavioral patterns associated with saving and investment can be modified. This is a much broader social process than altering tariff schedules, negotiating deals with manufacturers of particular products, or even changing government fiscal policy. It is harder for governments to address such broad social issues directly.

Over the past two decades, as a result of unsatisfactory economic experiences, opinions about appropriate and inappropriate diagnoses and policies have changed. Something approaching a diagnostic and policy consensus has emerged in both industrial and developing countries. Here are the commandments of the modern decalogue:

(1) The most fundamental lesson is that long periods of the application of an inwardly oriented import substitution industrialization are harmful, even in countries such as Brazil or India with very large domestic markets. A separation from the world market produces an inappropriate price structure, which generates misleading signals for the allocation of resources, and as a result misinvestment. Governments are sometimes tempted and sometimes forced to manipulate the internal price structure to the advantage of influential groups. The result is an overall economic loss. The world market does not simply provide “competition” that might stimulate innovation and development; it also provides the only reliable and effective guide to the appropriate distribution of scarce resources (and a much better one than could be given by any government planner). In addition, the turning of the internal terms of trade to the disadvantage of agriculture contributes to the growth of rural poverty and to the generation of extreme disparities of income and wealth. The consequences are socially and politically destabilizing.

(2) Links with the capital market affect the course of development. Industrialization or development that proceeds through a series of abrupt stops and starts as a result of changing conditions on international capital markets can carry harmful economic and political consequences. But capital movements are an essential part of the development process. There is a need to ensure that there are no substantial misallocations that might produce an abrupt reversal of confidence and a capital outflow. Again, the economically optimal outcome is best produced by letting a price system respond to market conditions. A code for capital liberalization might be a desirable successor to the existing IMF code requiring a movement to current account convertibility (under Article VIII of the Articles).14

(3) There are times when it appears that the markets do not necessarily always “know best” (though governments acting on their own usually “know even less”). Major failures of coordination between countries can produce dramatic shifts in the pattern of capital movement. Steady and coordinated policies are required for capital allocation to be made in accordance with the appropriate judgment by the market of long-term development potential. States have to help the markets know best by pursuing consistent policies, through time as well as among countries.

(4) The public sector is a major player in capital markets. It appears to offer potential investors the greatest security. But in an uncertain world, such security has its disadvantages. State borrowing may be less appropriate as a means of facilitating market judgments than borrowing and investing through corporations and individuals. There are then a much larger number of judgments being made about the economic future, and there is scope for some to be right (succeed) and for others to fail. States may feel the temptation to steer against the judgment of the markets and then, if such steering does not prove effective, to impose capital controls. These controls are rarely watertight and have not on the whole been effective instruments in stopping or reversing capital flight.

(5) In addition, large fiscal imbalances can be very destabilizing and contribute to a mismatch of national savings and investment. Balance of payments problems are often a consequence of excessive monetary creation for the purpose of financing fiscal deficits. But fiscal problems are often highly intractable, and can only be dealt with effectively within a wider framework of general structural reform.

(6) Overvalued exchange rates, which are often presented as an effective way of subsidizing basic or necessary imports, or as a means of fighting inflation, and are frequently supported by powerful and influential lobbies and interest groups, represent the equivalent of a tax on exports and harm long-term development prospects.

(7) Flexible exchange rates are not undesirable, and indeed often represent an ideal way of accommodating external shocks. Pegging exchange rates (in the manner of the classical Bretton Woods system) often may enhance the credibility of monetary policy, but may make necessary adjustments harder because of a fear of upsetting confidence. On the other hand, highly volatile exchange rates, which are often the result of the pursuit of inconsistent policies, have a damaging effect on economic performance and are likely to intensify calls for the adoption of protectionism.

(8) Monetary policy is best set by authorities that are as independent as possible of both the government (and associated political pressures) and the financial and banking sector (and associated day-to-day market pressures). It may be desirable to anchor the autonomy of the central bank through legal provisions.

(9) The process of economic growth everywhere—including in developing countries—can be profoundly affected by an inappropriate policy mix in the major industrial economies.

(10) There is no separate economic truth that applies to developed, or to developing, countries.

The one area—and it is an extremely important one—where no substantial agreement has emerged yet is over international monetary and exchange rate policy. In particular, the debate conducted since the 1950s in an academic milieu and since the early 1970s in policy circles between fixed and flexible exchange rates remains unresolved. Some commentators believe that the accelerated pace of internationalization makes the transactions costs imposed by the multiplicity of currencies an increasingly significant deterrent to economic activity.15 Others continue to argue that exchange rates are “just another price” and that like other prices they should be allowed to fluctuate freely, and give necessary signals for participants in a market. Like the academics, policymakers and political and business elites are divided. Businessmen frequently complain about the uncertainties caused by exchange rate changes. Many policymakers have often staked the it reputations on exchange rate stability: devaluations are viewed as a national humiliation; effective revaluations (in the surplus countries, which are highly export dependent) as a blow to the interests of exporters. On the other hand, if domestic costs and wages lead to an uncorrected movement of the real exchange rate, the result will also be the imposition of a distinct economic cost; and adjusting the exchange rate will often be the only politically feasible way of avoiding an underutilization of resources, idle plants, and an unemployed labor force.

Adjustments in exchange rates provide a way of compensating for sudden changes in supply conditions, and perhaps also of compensating for mistakes or misjudgments in the policies of national governments. There is in fact general agreement that the avoidance of policy mismatches would lead to greater exchange rate stability (while the stabilization potential of exchange rate intervention is far lower); and also general agreement that this outcome would be desirable. In this way, greater exchange rate stability might be expected to be the outcome of other areas of policy consensus: it is more likely to be achieved in this way than as a consequence of the creation of pre-set commitments by policymakers, which would only represent an open invitation to the testing and second-guessing through market sentiment. The increased extent of this guessing about the likely consequences of policy might in itself make the markets more disorderly and produce increasingly volatile exchange rate behavior not linked in any way to underlying “fundamentals.”16 Exchange rate stability could in short be seen as a desirable outcome of policy, but not as a very useful policy instrument.

The aspects of the “new consensus” listed above are the product of a number of circumstances, which have culminated in the evolution of an intellectual conversion. It was not an outcome, however, of any great idealism about international cooperation. One of the enchanting peculiarities of the intellectually divided climate of Bretton Woods was its remarkable and persuasive vision of international harmony despite all the differences in national approaches. That degree of good will was needed, at that stage, precisely because of the absence of agreement. As the initial enthusiasm waned, as it was bound to do, other considerations became important. First of all, initially the lessons about openness were drawn by some development economists and then accepted more generally. An intellectual consensus, however, is not enough by itself to produce a policy effect. Academic economists, for instance, have consistently pointed out the economic losses inherent in trade protectionism, and for much of the last two centuries there has been something approaching a theoretical unanimity on this issue. That fact did not stop governments in the late nineteenth century, or more disastrously in the 1920s and 1930s, or again after the 1970s, from taking up protectionist measures.

Rather, the world was battered into the new consensus by the repeated shocks experienced over the past two and a half decades. Indeed, perhaps paradoxically, it was those societies that were most exposed to the external shocks and that did not attempt to cushion themselves through accommodating monetary or fiscal steps that learned most quickly the lessons about the gains to be derived from openness. This was one of the features of the successes of the East Asian experience, where economies dependent almost entirely on imported energy found themselves very vulnerable in the 1970s. On the other hand, societies that attempted to isolate themselves often found that they were hit by a shock magnified as a consequence of delay.

In addition, countries learned from the experiences of others. Often the experience of a particular national crisis was required to drive home the lessons already learned in other contexts: in Germany after 1945, in Spain in 1959, in Korea in 1960, in the United Kingdom in 1976, in France in 1983, in the United States in 1985, in Mexico in 1982 and 1985, in India in 1990 and 1991, or in the almost permanent crisis of Soviet-style economies in the 1980s. Some commentators have come to the conclusion that we need to experience a crisis in order to adjust our views. The modern economy, according to one dramatic analogy, is a giant plodding forward while always looking backward. It is only when the giant trips that he gets a glimpse of the future as he stumbles.17 Do we always need to face near catastrophe in order to adjust ideas and policies?

An easier way of coming to terms with changes is to learn from the experience of others. We might try to equip the backward-looking giant with a system of lenses and mirrors, so that he knows what other giants are doing and can see a better way forward. Providing these reflective glasses is part of the surveillance function. One of the most important developments of the postwar era, and one which became more intensive during the course of the 1980s, has been the internationalization of the learning process. Ideas and knowledge have become an international commodity. The success of export-oriented industrialization in Asia demonstrated to Latin American economists and policymakers the drawbacks of import substitution strategies. East European states in 1989 learned from the successes of German adjustment programs in 1948, of the East Asian newly industrializing economies in dealing with the oil crises, and of the adjustment of Chile or Mexico after the debt crisis. The experience of the first reformers in Poland, the Czech Republic, and Hungary, in turn may serve as a pattern for later reform initiatives in formerly centrally planned economies.

In many cases the transmission of this learning has been through high-level technocrats, who have often either been educated or worked abroad: such as the “Ford Foundation gang” who stabilized Indonesia in the late 1960s, or the Chilean “Chicago boys” from the exchange program of the Catholic University of Santiago or individuals in Central Europe in the 1970s and 1980s who went to North American universities (such as the Czech Václav Klaus).18 Working in international institutions, especially in the World Bank and the IMF, has been an additional way of consolidating and sustaining this “technocratic learning” and creating an international community of ideas between central bank and finance ministry officials.

The converse of the experience of learning from other countries’ experiments is that those states that insist most vigorously that their problems and positions are quite unique and incapable of comparison find themselves sooner or later in trouble. This is true of cases as diverse as the United States in the early 1980s, which believed that it had found in tax cuts a unique key to growth, or Brazil’s insistence in the 1960s and 1970s on the virtue of import substitution as a strategy for countries with exceptionally large domestic markets. In medical experience, the realization that one’s problems are not singular is an important step on the road to health: the principle holds true for economies as well.

One of the major contributions of surveillance to the development of the international economy has been an institutionalized mechanism for sharing and learning. The fact that the move to consensus was so often accompanied by shocks indicates that its continuation may depend not only on a general preaching of “sound economics” but also on specific help in micropolicy advice and the design of economic institutions (central banks, fiscal systems), as well as in the provision of resources in dealing with the aftermath of shock. Surveillance allows the dissemination of economic information including advice on successful strategies (as well as examples to be avoided of unsuccessful strategies). It also provides a mechanism through which states can influence the other actors in the system: through the transfer of information, and through discussions in the context of multilateral surveillance. In the past, a major channel for the supply of this information was through governments and through technocratic discussions among high-level officials; this will undoubtedly continue to be the case to a considerable extent in the future. The opening of many societies, and the increased importance of public discussion, also requires an increasing openness about information and about economic prescriptions; and this new openness too has been one of the features of the maturing of the surveillance process.

In this way, with enhanced publicity, the IMF’s “machinery for consultation and collaboration on international monetary problems” has evolved into a source of institutional and structural innovation and reinvigoration. As a result of the demand for surveillance, it has developed into a continual process. The periodic Article IV consultations are the basis of biannual World Economic Outlook exercises involving the gathering, synthesis, discussion, and reporting and transmission of information. These exercises are as a result continually in motion; in addition, there are regular and more frequent sessions of the IMF Executive Board devoted to development in world markets.

The rule of Bretton Woods has been replaced by knowledge; an information standard has succeeded a gold or dollar/sterling or dollar standard; and the influence of the institution at the heart of the international financial system depends largely on its ability to provide speedy, accurate, and persuasive economic analysis. This is the consequence of the emergence of capital markets, which make it impossible for the international system to police and control national policies, as it had done until the 1960s. It is this development that makes it increasingly inappropriate for the Fund to be used in the manner of the 1960s and 1970s, as a scapegoat or political lightning rod for weak governments frightened about the loss of political popularity. An important part of any economic reform process lies in explaining why it is desirable and what the benefits will be; and this cannot simply be done by pointing at an outside institution. Already before the First World War, a British Prime Minister, A.J. Balfour had argued that “democracy is government by explanation.” Governments need to explain more; and so also do international institutions. Such openness is a necessary consequence of their accountability. The redefinition of the Fund’s role reflects a general shift in the global allocation of responsibilities between the public and the private spheres, with an increasing preponderance of the latter—the general transfer of the activity of choice to the collective outcome of millions of independent decisions. But the role of international institutions also will reflect the possibility of a collective dysfunction of the private sector and the need to deal with the consequences of potential breakdowns.

The financial function of the Fund is as a supplier of liquidity to countries with inadequate access to the market because of market failures: sometimes a failure of the international market (such as in the generalized crisis of confidence brought by the international debt crisis of 1982, where the Fund had to step in to marshall the market); sometimes a weakness or inadequacy of domestic markets of the kind that characterizes many low-income countries. In the case of the latter, there is poor or no access to capital markets. In these circumstances, the Fund operates as a gateway to the international financial system. The contribution that is made by international institutions is both immediate and longer term. The surveillance exercise is intended (in these as well as in the other cases) to make markets function more effectively. In a perfectly functioning world, there would be no need of the Fund as a financial institution, because the reserves of confidence built up would be sufficient to make impossible the outbreak of panics or crises. It is scarcely necessary to point out that this world does not at present exist, and is not likely to be created in the immediate future. However, what already does exist is the intellectual framework (the “new consensus”) with which it might be constructed; and the institutional framework, through the universal Bretton Woods institutions to supervise and advise policies in line with that consensus.

Since the (relatively recent) rise of the consensus, calls for a new Bretton Woods, or for a new redesigning of the international monetary system, have become much more narrowly focused, and not simply on grounds of practical difficulties in the way of achieving a far-reaching revision. In 1989, Robert Solomon still stated that “a desire for reform is sitting in the breasts of numerous economists and of the officials of some countries.” By 1991, Otmar Issing was claiming that “a reform of the world monetary system á la Bretton Woods is neither possible not necessary.”19 Instead of massive reform, most suggestions require instead only a modest tinkering: the issue of new SDRs for developing countries or countries in transition, or more effective ways of implementing and realizing surveillance, or the delineation of responsibilities between the IMF and the World Bank, or the IMF and the BIS, or the IMF and the World Trade Organization (WTO). One of the reasons for the greater degree of realism about the international system is a greater measure of success in its operation.

The increasingly widespread adoption of policies based on the consensus, especially in many developing countries since the mid-1980s, has led to results in the form of higher growth. (In only one year since 1985 did growth in developing countries fall below 3.5 percent, and developing countries as a group grew at high rates in 1992 and 1993 as they recovered from the world recession of the early 1990s.) The willingness to see expanded trade as an engine for growth resulted in the successful completion of the GATT Uruguay Round, with the extension of GATT principles to textiles and intellectual property, and in the agreement to establish the WTO. Largely as a result of the commitment of fast-growing developing economies to the central liberal vision of the Bretton Woods era, the dangers of a “new protectionism” on a global scale were lessened.

At this stage, the reader may feel some hesitation. Obviously not all intellectual differences over economics are solved, not are they likely to be. Perhaps the extent to which the new “mono-economics” has achieved a practical and intellectual ascendancy should not be overstated. The single world economy may not be necessarily intellectually or theoretically appealing to every observer. Politicians, decision makers, businessmen, bankers do not always feel themselves to be part of a single universally applicable system. They are often eager to castigate the modem consensus as too short term, too chaotic, too liberal, and sometimes also as too Anglo-Saxon. They complain that excessive liberalization may make impossible a steady policy approach. They claim that large capital flows may undermine exchange rate stability, and thus may make it harder to formulate a long-term view and instead lead to “short-termism.” They say that the costs of liberalization have been too high and have produced unacceptable shifts in income distribution, that globalization has led to the pauperization of unskilled workers in some industrial countries (notably the United States), and permanently high unemployment levels in those countries with more generous social security systems that stood in the way of wage adjustment. Or the critics demand that the state should play a larger role in development than is provided for in an approach which they castigate as “doctrinaire.”20

Some observers occasionally present the East Asian success story as less a victory of liberal economics than an outcome of a tradition of economic planning. In particular in countries where past attempts at planning have failed, often dramatically, institutions or individuals with a historic commitment to the planning approach have tried to draw the lesson from rapidly growing newly industrializing economies that policy directives may work better than a market. Some Japanese observers have made the claim that the strength of the Japanese economy derives from a dirigiste approach that may make the Japanese experience particularly relevant to the problems of formerly centrally planned economies.21

In addition, the argument may not simply be about economic efficiency. It should also be concerned with a wider arena, and with more fundamental human problems. How can the demands of justice be reconciled with those of international economic stability and growth? What is the nature of the trade-off between justice and growth? No international order can survive for very long if it is widely perceived to be fundamentally unjust. Avoiding large disparities of wealth and income within national economies may be a prerequisite of social justice; but it is also clear from many examples from the world’s most dynamic economies that a better distribution is often accompanied by faster growth. Within national economies, policy reforms aimed at preventing the pauperization of the unskilled may in the longer run best be directed to generally raising skill levels.

The same principles will be true internationally: a world in which a large number of very poor countries continue to be very poor is also a world that unnecessarily limits opportunities. Combating poverty is as a consequence an essential task of the international community if it wishes to create a stable system. It should also be a part of the program design of international institutions such as the IMF (which has indeed paid more attention to these issues over the course of the 1980s). The current Managing Director of the IMF frequently refers to poverty reduction as an essential “fourth pillar” of any adjustment program. The crucial element in this strategy is the design of social safety nets, to prevent the immiserization of those displaced in the course of an economic restructuring. In the absence of such nets, it is often impossible to gather sufficient support for a radical market-based economic reform. An additional political dimension may mean that the creation of an adequate support system is blocked by vested interests attempting for their own ends to stymie the process of economic reform and liberalization.

This struggle for justice needs to be conducted within the general framework of a system that offers incentives for alteration and improvement, rather than working through restraints and coercion. Attempting to deal with injustice in the past has too frequently involved the imposition by authorities of restraints that produced perverse and perhaps unintended consequences and that led to greater injustices. Penal taxation as a way of redistributing wealth and income, or intervention in price-setting in order to determine the allocation of resources between different sectors of the economy has too often produced a system of disincentives, which only the exceptionally ingenious or politically well-connected can work out how to avoid. Liberalizing is frequently a part of any effective campaign against poverty. On the other hand, it is not enough by itself. A participation of richer countries in the exercise of creating incentives is unavoidable. This may involve specific transfers for particular projects; or a more radical and far-ranging approach to the disincentives created by the presence of large external debt. The chances of dealing with poverty through investment in broadly based education, in health, and in infrastructure, all involve creating better opportunities for larger numbers of people. Such an approach is not only compatible with increased international openness; it is an indispensable part of such an opening.

Finally, even a theoretical consensus may not have hard policy consequences. Many countries continue to say one thing while doing something completely different. Although there may be a new intellectual orthodoxy, practical interests continue to push politics in a different direction. For a variety of reasons, countries experience pressures—political, social, demographic—that make it hard for their governments to return to fiscal balance. As a consequence, many governments throughout the world engage in largescale dissaving. Many industrial countries have accumulated large and unfunded liabilities to a future in which their populations will age rapidly. In addition, whatever the theoretical attractions of an open economy, there are many interest and pressure groups that push in the opposite direction. Often the losers in a move to openness have an acute sense of their losses, while the potential beneficiaries cannot clearly perceive the extent of gains that lie in the future (and whose distribution is not clear). In these circuitistances, international institutions that reinforce the lessons of the international consensus can play a valuable role in countering the harmful influence of specific pressure groups. The international community and international institutions are often defenders of the “general interest” in national debates where particular interests can organize and articulate themselves powerfully but to harmful effect.

These and other partial reactions against internationalization and the emerging economic policy consensus may be inevitable. Policymakers may talk and talk about trade openness, the limitation of fiscal deficits, and decontrol of prices, but often in practice they find it difficult to act on these fine principles. They will invariably be pushed by a wide variety of domestic interests that often see strong particular gains from not being open. The result of such pressure may be beneficial to the powerful and articulate, but carry an overall cost for the society. One result of the consensus, however, is that it can be invoked as a justification for a policy that can deliver higher overall gains. As a result, few now any longer see a fundamental opposition between the requirements of the international system and the priorities of the national economy. Even more significantly, many have begun to see the international order, and international debate, discussion, and surveillance, as valuable allies against the ascendancy of particular political and economic interests.22 In this way it provides an essential component, not just of the international financial system, but of a mechanism for the creation of wider stability and of an international society that is more just.

The Overlap

The provision of global surveillance raises some questions about the links between international organizations and their spheres of action. There ate several institutions dealing with some aspect of international economic, and particularly monetary, cooperation. The key issues in the future will be:

(1) The management of global liquidity. One of the central developments of the postwar period has been the dramatic growth in private sector markets. Liquidity is no longer expected to be supplied by international institutions. The problem of regulation has not disappeared, however; the international character of finance requires a cross-national cooperation of regulatory authorities. In the past, both the IMF and (more directly) the BIS have been concerned with such regulation. How will it be managed in the future? If for the past twenty years, the most crucial bilateral institutional relationship of the IMF was with the World Bank across 19th Street in Washington, a major theme of the next twenty years will be contacts between Washington and Basle. As lending takes place more and more across national frontiers, involving different national regulatory authorities, and in the case of financial crises major international adjustment problems, an international lender of last resort has become more essential as part of the world monetary system. The debt crisis of 1982 demonstrated the way in which such a need brought the IMF and the private financial sector together.

(2) Adjustment policies. The evolution of a longer time horizon, and the degree of access of industrial and even many middle-income countries to private markets, has brought the World Bank and the IMF closer together in dealing with the problems of poorer countries. Their functions remain separate, in that the IMF is primarily a monetary and not a development institution; but effective institutionalized cooperation between the two is needed if there is not to be a widespread rejection of the Bretton Woods twins on the part of their members, clients, and owners.

(3) Confidence. There is a need for a stable policy framework among the members of the international financial system. In the recent past, this has been the task of the G-7. Reasons have been set out above for thinking that this might better be tackled by a genuinely universal institution, and within the framework of the IMF.

To this classical trinity of considerations in an international financial system should be added a fourth:

(4) Trade policy. One of the raisons d’être of the IMF was to prevent monetary policy being used as an instrument of trade wars; and the first Fund Article of Agreement refers to a duty “to facilitate the expansion and balanced growth of international trade.” In the process of IMF surveillance of exchange rate policy, the liberalization of trade and the priorities set in the new World Trade Organization will be a major consideration. It has repeatedly been demonstrated that trade liberalization is one of the most important components of effective and sustained economic reform and adjustment. The agreement establishing the WTO requires it to cooperate with the IMF and the World Bank to achieve “greater coherence in global economic policy making,” but as yet the contents of such coherence have not been made clear.

The world faces an institutional choice between an order in which these aspects of surveillance are fragmented and treated in separation, with a smaller IMF (Figure 17-2) or, preferably, one in which the elements of surveillance are more effectively coordinated, with a stronger IMF (Figure 17-3). The case for greater coordination between international institutions rests on the substantial extent of the linkages that exist between different global economic problems. Issues such as interest rate levels, macro-economic orientation, debt problems, and capital flows cannot be treated adequately in isolation from each other.

Figure 17-2.Small IMF

Figure 17-3.Large IMF

A long run historical view can help in providing a useful antidote to two common errors in policy formulation. The world and its leaders tend to lurch dangerously between two opposite poles: either an exaggerated belief in the intractability of problems or an overconfidence as to their solubility. At some times almost all the experts, politicians, and media agreed that the horizon was clear, with no problems or dangers in sight. At other points they also held a consensus view, that the difficulties were too overwhelming, the sacrifices required too great to be bearable, and the world’s available statesmanship too puny to deal with the task in hand. These overextreme answers to the question of whether and how the problems of the international system might be solved have been formulated regularly, with regard to a whole range of issues. Hubris and despair chase each other in quick succession, as contemporary opinion swings between optimism and an incapacitating pessimism. Whether the question at stake was recovery from the interwar Great Depression, the reconstruction of Europe and East Asia after the war, the monetary inflation of the late 1960s, the oil price shocks of the 1970s, the debt crisis of the 1980s, the structural problems of sub-Saharan Africa, or the transition from centrally planned economies, all provoked extremes, sometimes of confidence, and sometimes of self-doubt. The task of international institutions, and of the surveillance process, is to ensure that both are avoided and that problems are analyzed, understood, and then tackled.

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