“The substitution of a credit mechanism in place of hoarding would have repeated in the international field the same miracle, already performed in the domestic field, of turning a stone into bread.”

“The substitution of a credit mechanism in place of hoarding would have repeated in the international field the same miracle, already performed in the domestic field, of turning a stone into bread.”

John Maynard Keynes, in Horsefield, 7969

THIS PAPER WILL CONSIST of two parts. The first will focus mainly on a short review of changes in the international economy, with particular emphasis on those that have occurred since 1972, and will discuss briefly the international response to them, in particular by the International Monetary Fund. In the second part, a possible agenda for reforms of the Fund will be examined, discussing both issues that have already been extensively debated (but may need to be seen in a new light as a result of recent developments) and those that have acquired particular relevance as a result of recent changes. Among the former issues discussed are: the coordination of national economic policies; the role of the Fund in the creation of world liquidity; the adaptation of the Fund’s lending facilities; and the type of conditionality attached to Fund lending. The two issues that have recently become relevant, and therefore seem particularly to require further technical clarification at present, are: relations between the Fund and other official international institutions as well as private international banks; and the possible need for special measures to support both countries and groups of people most vulnerable to international instability and shocks.

Changes in the International Economy

The Fund and the World Bank, as well as the overall system created at Bretton Woods, clearly represented a bold attempt to promote multilateralism in a universal system. It contributed to postwar reconstruction and to the remarkable period of growth of world production and trade in the 1950s and 1960s, leading to a degree of international cooperation that was significantly greater than that achieved in earlier periods.

However, the gaps in the Bretton Woods System and the small and (relative to the world economy) declining size of its main institution—the Fund—have eventually led to increasing contradictions, which, particularly since the early 1970s, seem to have made its contribution to the growth of world output and trade more ambiguous. Several thoughtful analysts have suggested that, had the Fund been created along the lines suggested before and during Bretton Woods by Keynes, its contribution to the sustained growth of the world economy would have been greater and more permanent (see Williamson, 1983a). It is noteworthy that suggestions for major reforms of the Bretton Woods System (such as the Triffin Plan, the suggestions of the Committee on the Reform of the International Monetary System and Related Issues (the Committee of Twenty), and proposals in the Brandt Commission reports) contain crucial elements that are similar (or are based on similar principles) to those in the original Keynes plan—in particular the proposals for a far larger Fund, for a larger role for the international currency it issues, and for effective mechanisms to exert pressure on surplus countries (see Keynes in Horsefield, 1969, for Keynes’ proposals). Naturally, not all—and perhaps not even most—of Keynes’ detailed proposals for an International Clearing Union would be relevant in today’s significantly different world. Similarly, many of the current difficulties with the operation of the international financial system and of the Fund are not only due to the original limitations and gaps of the system, but also to its slowness to adapt to the rapid and drastic economic and political changes that have occurred in the last forty (and particularly the last fifteen) years.

There are four major changes in the world economy that seem most relevant to the discussion of the present and future role of the Fund. (1) The first issue is the increased economic, and particularly financial, interdependence that exists in the world today. This is reflected in the very rapid growth that has taken place in world trade and international labor flows, and, particularly since the early 1970s, the dramatic expansion of private financial flows. The internationalization of private financial flows was (especially in 1973–82) far faster than the internationalization of the relevant regulations, and faster than the expansion of official international lending—including the Fund’s. Indeed, many of the proposals discussed below would expand the Fund—as well as other public international institutions—as much as the private sector has already expanded. Some analysts are even beginning to draw a parallel between the development of national central banks that followed the growth of commercial banks, and the gradual evolution of the Fund into an embryonic world central bank following the growth of international private banking (see Cooper, 1983). At another level, greater international interdependence also implies a need for more coordination among countries in the management of their macroeconomic policies—a process in which the Fund, given its mandate, experience, and influence would inevitably play a key role.

(2) The larger and different payments problems of today constitute a second major change. During the 1970s and early 1980s international financial intermediation became much more difficult due to the dramatic increase in the size of current account imbalances that occurred as a result of major variations in the price of internationally traded goods (particularly but not only oil), recessions in the industrial countries and—in the early 1980s—major increases in international interest rates. Particularly problematic and severe was the large increase in the current account deficits of oil importing developing countries, which grew especially sharply, from $11.3 billion in 1973 to $109 billion in 1981 (International Monetary Fund, 1980 and 1984b).

Though positive, the response of official international institutions—and particularly of the Fund—to the magnitude and severity of the balance of payments problems of oil importing developing countries was clearly insufficient. It has perhaps not been stressed enough in the literature that between 1973 and 1982, the Fund through all its facilities financed only 3.1 percent of the current account deficits of non-oil developing countries (see Table 1). Clearly, the responsibility for the very marginal role in funding deficits that the Fund played until 1980 is not mainly carried by the institution itself, but by the governments of its member countries. For example, the expansion in the Fund’s resources could have been more rapid; the ratio of Fund quotas in relation to world imports in fact declined particularly sharply (from 12 percent in 1970 to 3 percent in 1982) when current account imbalances grew fastest in the world economy.

Table 1.

Current Account Deficits and Net Use of Fund Credit, Non-Oil Developing Countries, 1973–83

(In billions of U.S. dollars)

article image
Source: International Monetary Fund, World Economic Outlook (Washington: IMF), various issues.

It is true that the Fund did take important steps in response to changes in the international economy during the 1970s. Among these, and of particular importance in this context, was the creation of the low conditionality oil facility, the extended Fund facility (EFF), the Trust Fund, the Subsidy Account, the Supplementary Financing Facility, and the enlarged access policy. But given the tremendous and unprecedented magnitude of the deficits that needed to be met, the official response was insufficient, and contributed—particularly by omission—to the problems in some countries (especially the low-income nations) in the 1970s, and in most developing countries in the early 1980s. The evaluation of past mistakes made in response to changes jn the international environment is important—not to apportion blame (an outsider with the benefit of hindsight would be presumptuous even to attempt that) but to extract lessons for the future.

(3) As the financing needs of most developing countries increased dramatically, and as the expansion of official liquidity, development assistance, and private direct investment failed to keep pace, the gap was in large part filled by lending by the international private banks. This was the third major change in the world economy. This lending was highly concentrated, helping to sustain economic activity in particular developing countries (such as the middle-income ones) and thus indirectly to sustain economic activity worldwide. The low-income countries, mostly considered uncreditworthy by commercial bankers, did not, however, have significant access to this new source of liquidity, even in the 1970s. Thus as the main source of international liquidity for financing developing countries became market determined, the distribution of this liquidity among developing countries became less equitable than it had been, when aid and official flows played a relatively larger role, as in the 1960s.

Private bank lending also created other problems. As became evident in the early 1980s (but should have been clear to anyone with at least a superficial knowledge of economic history), private international lending is unpredictable and may often become procyclical; there was and still is no assurance that levels of future net lending flows will be related to past levels, since they are to an important extent influenced by bankers’ perceptions of countries’ creditworthiness, which deteriorates precisely in periods of world recession. Not only has new commercial lending itself become procyclical, but the interest payments on a large proportion of debts contracted earlier have varied according to international interest rates. This variable interest rate debt, which helped fund a high proportion of the deficits of some developing countries in the 1970s (contributing to their sustained economic activity) itself became an additional and important new channel for the transmission of international disturbances.

Price instability, which has for long been perceived as an important source of instability in earnings from the commodity exporting developing countries, also became a characteristic of the transfer of financial resources. As Massad (1984) clearly put it: “Interest rates, terms of trade and the supply of lending interact perversely in the international transmission of disequilibria.” The “perverse” interaction between high interest rates and the supply of private lending even led in 1982 and 1983 to significant net negative transfers of financial resources from most Latin American countries (their net payments of profits and interest being greater than net capital inflows), and from Latin America as a whole, and there are risks that such a situation could occur even for some low-income countries (see United Nations Economic Commission for Latin America, 1984). Although it may be desirable that in the medium term some developing countries may “graduate” to a position of becoming net exporters of capital, this seems clearly premature and undesirable at this stage, not only for the low-income but also the middle-income countries attempting to emerge from the impact of a major world recession.

(4) The combined effect of the second large increase in oil prices, the prolonged recession of the early 1980s and the dramatic rise in international interest rates—and, for some countries, seriously inadequate economic management—led in the early 1980s to the fourth major change: widespread debt crises in developing countries. The Fund played a major and vital role in preventing these crises from having a destructive effect on the private international financial system.

The role the Fund played went far beyond its greatly expanded direct role in financing developing countries’ current account deficits, although the Fund’s lending did increase significantly in value and as a proportion of financing current account deficits, and it also became more widespread. As Jacques de Larosière, the Fund’s Managing Director, pointed out, “since the debt crisis erupted in the middle of 1982, the Fund has lent some $22 billion in support of adjustment programs in nearly 70 countries” (de Larosière, 1984). Particularly important in times of financial distress has been the Fund’s key role in assembling rescue packages; these have included an upper credit tranche program with the Fund, the rescheduling of maturing debts, and the arrangement of new finance from banks. The latter has often been largely “involuntary” as the Fund has placed considerable pressure on banks to increase lending (usually to meet interest payments).

It is noteworthy that in these packages the Fund’s financing has been made conditional for the first time not only upon policy changes in the debtor country, but also upon the extension of new credit by private international banks. Furthermore, whereas before 1982 the Fund “restricted an area of competition and reduced the possibility of ‘excessive’ private lending and borrowing” (see Eckaus, 1982), as its programs included a limit on countries’ foreign borrowing that set the size of a particular market for private lenders, since 1982 the Fund has to some limited extent “created” a market, by encouraging or even pressing private banks to lend when they did not necessarily wish to. These changes in the relations between the Fund and the private capital markets have not been sufficiently stressed in the literature, nor have their present and future implications been fully examined (this subject is returned to below).

The major and effective role which the Fund has played in debt crisis management has been widely acclaimed as having been of immediate benefit, not only to the banks, but also to the debtor countries and to the international economy. Not only has the influence of the Fund greatly increased, but also its prestige as the institution at the center of the international monetary system has been significantly enhanced. There is also a rather widespread view that as much or more creativity and energy as was involved in debt crisis management should now be used to design an international monetary system that would contribute to making those crises less likely and less damaging both to the world economy and, particularly, to the developing countries.

Issues in the Reform of the Fund

It is relevant to recall the Fund’s objectives at this juncture, as expressed in its Articles of Agreement. They include (with my emphasis):

  • To facilitate the expansion and balanced growth of international trade and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.

  • □ To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.

  • □ To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.

A senior Fund official, Walter Robichek, has admirably summarized the Fund’s objectives and raison d’être in one sentence: “The IMF was founded to avert worldwide economic depressions” (Robichek, 1984).

Given the recent changes in the world economy—some of which have been very briefly sketched above—and the new problems that these have generated, important alterations should perhaps also be made to the Fund’s role and modus operandi to help it achieve the purposes for which it was established. Perhaps the Fund itself, given its experience, its aims, and its increased leverage and prestige, should initiate proposals for international monetary reform (including significant changes in its own role), rather than leave this initiative to outside observers or individual member governments.

There seem to be two broad types of possible reform of the Fund. First, there are those proposals that have already been explored in the literature (in some but not all cases exhaustively); these proposals may need some important adaptations due to recent changes, but the main impediment to implementing them seems to be a combination of a lack of political will among the particularly influential national governments and some institutional inertia within the Fund itself. This type of reform includes improving the coordination of national policies, increasing the Fund’s contribution to global liquidity, expanding the Fund’s existing financial facilities, and modifying the conditionality attached to its resources.

The second type of reform involves new issues that have become significant more recently, mainly as a result of changes in the world economy. Further technical clarification of these issues may still be a necessary though obviously not a sufficient condition for future change. It is worth exploring two issues in this latter category: the future relations among the Fund, other official international institutions, and the private international banks; and the possible need for special measures to support both countries and groups of people most vulnerable to international instability.

The shocks and instabilities that have characterized the world economy in the past twelve years imply the need within a reformed international system to improve stabilization and contracyclical policies, and the protection of those most affected when instabilities and shocks nevertheless persist. In the past, national instability has generally increased recognition of the role of automatic stabilization devices for national economies. But there has been little parallel use of automatic stabilizing mechanisms at the international level, although the need for more international action to avoid recessions is perceived as essential by economists belonging to different schools of thought. Important elements in automatic or quasi-automatic international stabilization have to do with the provision of stable and adequate international liquidity, and the maintenance of stable and above all predictable flows of international capital. These topics will be examined later. This section will concentrate on the other key tool of international stabilization: the more effective coordination of national stabilization policies.

These are clear difficulties in achieving total agreement among governments of varying powers, political persuasion, and economic interest on what optimal economic policies are, whether national or international. It may, however, be possible to develop arrangements in which the international implications of domestic policies are more explicitly and systematically taken into account at the national level. As a fairly recent Commonwealth Secretariat Report points out (Helleiner, 1983):

Multilateral participation in macro-economic consultations and coordination efforts, even when the main issues relate to policies of relatively few major economies, is necessary because the effects of whatever policies are agreed have ramifications far beyond the borders of the industrialized countries…. The most obvious existing multilateral forum for macroeconomic consultation is the IMF.

One way to achieve such coordination effectively would be for the Fund to take a view on a viable global pattern of current account deficits and surpluses (or on a set of current account targets), and, through the different mechanisms at present at its disposal, to attempt to guide and coordinate the policies of both deficit and surplus countries to achieve those targets. As Killick pointed out in the Commonwealth Secretariat Report quoted above, the Committee of Twenty agreed in the mid-1970s that the system would develop in this direction; furthermore, this type of evolution was also clearly implicit in Keynes’ proposal for an International Clearing Union. More recent suggestions in a related field, such as Harold Lever’s scheme to sustain commercial lending to developing countries by expanding government guarantees, are also linked to a set of current account deficit targets that the Fund would define and monitor (see Lever, 1983).

It would be of key importance, if the Fund is to play such a central part in policy coordination, that its role should take account of one of its main purposes established in its Articles of Agreement “to facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.” If such objectives were not clearly pursued, there would be a risk, although presumably a small one, that policy convergence could even lead to a stronger deflationary bias than has characterized economic policies during some recent periods.

Nevertheless, a more global perception of countries’ adjustment might de facto reduce deflationary (or indeed excessively inflationary) biases in policymaking. It has increasingly been pointed out that if deflationary policies are simultaneously pursued by a number of deficit countries, the total impact of such policies may contribute to a world recession or to a reduction of world economic growth without necessarily improving the imbalances on the current accounts of individual countries (see, for example, Griffith-Jones and Harvey, 1985). Focusing only on individual deflationary adjustments without accounting for the aggregate impact of those adjustments on world trade implies a certain “fallacy of composition.” In fact, international institutions that can look at national adjustment from a global perspective should be able to avoid such a fallacy of composition and their advice should tend to have far more expansionary implications than policymakers who see adjustment only from a national perspective.

The fact that programs designed with the assistance of an institution like the Fund do not in practice have an expansionary bias toward growth may be partly explained by its lack (in this aspect of its work) of such a truly global perception. It is very interesting that the senior official of the Fund mentioned earlier, Walter Robichek, has expressed this problem in a very clear and illuminating manner (Robichek, 1984, p. 74, with emphasis added):

Let it be admitted that the IMF now faces a certain dilemma. Although it has increasingly adopted a global analytical framework, foremost within the context of its rather elaborate annual world economic outlook exercise, it is not at present well equipped to deal operationally with balance of payments problems except on a country-by-country basis. The unfortunate consequence of the IMF’s country-specific operations is that there is a risk that it may become an accomplice to the very beggar-my-neighbor policies that it was created to avert.

The practical implication may be that the Fund should attempt to increase its influence over industrial economies, and to do so from a global perspective; however, this task—although essential in terms of economic logic—may be frustrated in the short term by the political difficulty of influencing countries that do not need to borrow from the Fund. This is confirmed by the limited impact that the Fund has managed to exercise through its regular consultation and surveillance procedures. It may therefore be more fruitful for the Fund to begin by applying a more global analytical framework, at least when dealing with countries that do request its credit. At a minimum it should consider the interactions of the policies it recommends to different countries.

The Fund should, for example, assess the impact on the trade and current balances of all countries of the policies it evaluates or recommends for individual countries, and particularly of devaluation and constraint on demand expansion. Given the large number of countries with upper credit tranche arrangements with the Fund now, and the importance of some of them in world trade, assessing the global effects of program policies (even though a second best to a global view of the adjustment of all countries) could be very important. For example, on April 30, 1984, as reported in the Fund’s Annual Report, 35 countries had upper credit tranche arrangements with the Fund, including such very large economies as Brazil and Mexico. Given the large number of upper credit tranche Fund programs at present existing in Western Hemisphere countries (10), and the significant volume of intra-Latin American trade, an initial attempt could be made to consider the interactions within that area. Particularly if this broader view is accompanied by other measures, some of which will be discussed below, such a change in analytical framework could imply a far more global perspective for the Fund, and reduce the bias in its recommendations toward deflation.

The insights, methodology, and experience gained in such partial global analysis may be useful for developing a truly worldwide approach toward adjustment, which may become politically more feasible; indeed, the political feasibility of a more global influence of the Fund on adjustment may be enhanced by a successful experience on a partial or regional basis.

It has traditionally been held that a crucial area of international monetary policy relates to ensuring an adequate and appropriately distributed supply of international liquidity. It is a key element in assuring a stable, noninflationary growth path for the world economy, and thus is intimately linked with the issue of greater global coordination of countries’ macroeconomic policies, discussed in the preceding section. Dooley’s paper in this volume marks a departure from their traditional thinking.

It should be stressed that in the 1970s the trend toward floating currencies and a multicurrency reserve system, combined with the great expansion of international bank lending, gave a new meaning to international liquidity. For a time, the gross supply of international liquidity became, for the creditworthy industrial and middle-income countries, virtually open ended. As a result, international control of liquidity became largely a function of the market. Thus, even after the creation of the SDR, Fund-created liquidity—either through its low conditionality lending or through the issue of SDRs—played a very small role in global liquidity; moreover, control by—or even the influence of—the Fund did not significantly affect the explosive expansion of market-based liquidity that did occur.

As the creation of market-based liquidity clearly slowed down in the 1980s (and as it is widely perceived that even in the 1970s the creation of liquidity through the market was often procyclical and frequently inequitable), the need to increase stability and predictability in the provision of international liquidity and to link it explicitly to the requirements for stable, noninflationary growth in the world economy became far greater. It is therefore even more essential than in the past to increase significantly the influence of the Fund over the supply of international liquidity, which is one of the purposes for which the Fund was created, and to increase the size of its multilateral creation of liquidity through SDR issues. In the 1970s it may have been difficult—or even superfluous, as some maintain—for the Fund to assert its influence over the magnitude of international liquidity; in the 1980s there seems little choice but for a greater role for the Fund, both direct and indirect, to avoid the possibility that international financial intermediation might impose a deflationary bias on the world economy. At the same time, thought should be given to the currently less urgent need to create mechanisms for supervising and regulating excessive expansion of private international liquidity in the future.

Adapting the Fund’s Facilities

Just as the role of the Fund in international coordination and in the generation of international liquidity needs to adapt to changing international circumstances, the same is true of the lending facilities through which the Fund provides credit to its member countries. This section will not deal with the creation of new facilities, but with the hopefully more feasible adaptation and expansion of two existing Fund facilities: the compensatory financing facility (CFF) and the EFF.

There emerged rather widespread professional consensus in the early 1980s on the need for an expansion and adaptation of the Fund’s CFF in response to the increased instability in the international environment. An expanded CFF is favored both by those concerned primarily with reducing the impact of instability in the world economy on individual developing countries (see Dell and Lawrence, 1980), and by those who see in the CFF the main mechanism through which the Fund does play—and could play—a significantly larger role in global economic stabilization (see Cooper, 1983); to these arguments could be added the contribution that the CFF (and particularly an expanded one) could make to the stability of international banking by breaking the set of vicious circles of poor trade performance, high interest rates, and financial distress that emerged in the early 1980s.

The main purpose of the CFF was spelled out in a special Fund pamphlet on the subject: “Ideally, the facility would enable a member to borrow when its export earnings and financial reserves are low and to repay when they are high, so its import capacity is unaffected by fluctuations in export earnings caused by external events” (Goreux, 1980, p. 3, emphasis added). In the late 1970s and early 1980s, the CFF became a major facility through which the Fund provided payments assistance to developing countries; compensating for shortfalls in export earnings in a low-conditional and agile manner. Its capacity for lending has been enhanced through several modifications, the last of which (in 1981) also allows for compensation for temporary excesses in the cost of cereal imports.

However, different studies showed that borrowings under the CFF have been relatively modest, given the magnitude of the deterioration in the terms of trade in the early 1980s of a large number of developing countries; in particular, some studies (see, for example, Williamson, 1983b) stressed the inadequacy of the CFF in compensating for the terms of trade deterioration in sub-Saharan Africa during that period. The main problems with the existing modus operandi of the CFF were generally identified as the quota limits on maximum drawings (clearly the most important constraint), the calculation of export shortfalls in nominal rather than real terms, and a formula for repayments not linked to the recovery of export earnings (see Griffith-Jones, 1983).

Different liberalizations of the CFF have been suggested to provide full (or at least larger than existing) coverage of export shortfalls, either by eliminating the link between the size of a drawing and the drawing country’s quota, or by increasing the limit. With the emergence of widespread debt crises in the early 1980s, the proposal was made in many circles that the CFF should also provide loans to offset fluctuations in interest rates (see The Economist, 1983, and Cline, 1984). This modification would have the merit of reducing the impact of one of the key new sources of international economic instability.

A CFF thus modified would be able to stabilize import capacity and compensate for externally caused fluctuations in export prices, import prices, and interest rates in cases of balance of payments need. It would be a very powerful counter-cyclical instrument, and be able to make a potentially major contribution not only to reducing the impact of shocks in the international economy on individual developing countries, but also to dampening instability in the world economy as a whole. Since one of the main features of the world economy since the early 1970s has been increased instability in key variables, and since this instability and the resultant uncertainty are seen as having negative effects by different types of economic agents and different schools of economic thought, measures to enhance prospects for stability could have broader support than the potentially more controversial issue of systematically increasing financial flows to developing countries.

It seems, therefore, particularly regrettable that suggestions of the type outlined above have not been followed up. In fact, the limits on drawings under the CFF as a proportion of quotas have been reduced, although the quotas themselves are higher. Of greater concern is the fact that, in September 1983, the Fund’s Executive Board passed a Decision (No. 7528–(83/140) which significantly altered the conditions under which the CFF drawings could be made. (See International Monetary Fund, 1984a, p. 167 for the text of the resolution, and Dell, 1985, for a criticism of it.) Until September 1983, the first half of CFF drawings required only willingness on the part of the country “to cooperate with the Fund in an effort to find, where required, appropriate solutions for its balance of payments difficulties,” which implied that in practice it had very little conditionality attached to it and that it could therefore be granted semi-automatically and speedily. The modified resolution says now that readiness to cooperate:

implies a willingness to receive Fund missions and to discuss, in good faith, the appropriateness of the member’s policies and whether changes in the member’s policies are necessary to deal with its balance of payments difficulties. Where the Fund considers that the existing policies…are seriously deficient or where the country’s record of cooperation in the recent past has been unsatisfactory, the Fund will expect the member to take action that gives, prior to submission of the request for the purchase, a reasonable assurance that policies corrective of the member’s balance of payments problem will be adopted.

The fact, therefore, that a country has experienced a temporary export shortfall (as defined by the Fund) for reasons beyond its control is no longer sufficient ground for a CFF drawing. The Fund can send out a mission and require the country to make changes in domestic policies (which are not the cause of that particular balance of payments need) even before a request for a drawing is submitted to the Executive Board.

As Dell (1985) points out: “a further blow has been struck at the competence and responsibility of the IMF by depriving it of the major part of its low-conditional resources.” There is in fact little left of the Fund’s low-conditional resources except for the (unconditional) reserve tranche and the first credit tranche, given the non-renewal of the Trust Fund and other low conditionality facilities established in the 1970s. As a result, the ratio of low and high conditional facilities has been dramatically changed since the mid-1970s, with what seems too severe a bias toward high-conditional facilities, particularly given the fact that unstable and unpredictable external events cause such a large part of developing countries’ balance of payments problems.

A related area of concern is that the Fund seems with this new Decision to have gone back on a clear distinction (expressed in its pamphlet on Fund conditionality by Guitián, 1981, p. 4) between “deficits stemming from adverse transitory factors [which] typically call for temporary resort to financing,” for which mechanisms such as the CFF were devised and “imbalances…due to permanent factors,” for which “appropriate measures of adjustment must be taken to remove them.” The distinction now appears blurred, and it seems possible that even in cases where balance of payments’ needs arise from temporary pressures (outside a government’s control), an effort of adjustment may nevertheless be required.

The larger payments imbalances facing developing countries since the early 1970s, as well as their different nature, have prompted many analysts to suggest the need for a facility more appropriate to the new situation. The Fund responded by creating the EFF in 1974. The rationale for the facility is clearly expressed in Fund documents. For example, the pamphlet on conditionality that appeared in the early 1980s had this to say: “The payments imbalances facing many members in the early 1970s required adjustment over longer periods than were provided for under stand-by arrangements at that time, and, therefore, required larger amounts of assistance than could be made available under such arrangements” (Guitián, 1981, p. 19). A similar analysis was made of the early 1980s (Guitián, 1981, p. 25):

There was general agreement that the imbalances that currently existed were structural and therefore not amenable to correction over a short period of time. Adjustments to such disequilibria were likely to require extensive changes in members’ economies… if the restoration of viability to their balances of payments was not to jeopardize their development and growth prospects over the medium-to-long term…. These considerations led the Fund to move toward a relatively long time frame for the adjustment effort to allow for changes in the patterns of production and demand—changes that can only be effected gradually.

Many analysts welcomed this adaption of Fund practice to changes in the international environment. The Fund’s own assessment seemed positive. For example, Guitián in the pamphlet quoted above wrote in 1981 that “in its formulation and administration, the extended facility has proved to be particularly beneficial to developing countries.” A major study evaluating the Fund’s impact by Killick and others (1984) concludes that though both stand-by and EFF arrangements frequently broke down, EFFs seem to have led to more satisfactory results on growth and inflation. More broadly, the EFF was welcomed as a genuine attempt to move toward long-term and more structurally oriented programs.

Modifying Fund Conditionality

The issue of Fund conditionality is the aspect of the Fund’s role most frequently and extensively debated in the academic literature, as well as in far wider circles. Although the subject was widely discussed in the 1970s in the academic literature, its relevance has increased significantly in the early 1980s for the following reasons. First, a far larger number of countries than in the past are borrowing from the Fund. Second, the proportion of the Fund’s high conditionality lending has dramatically increased since the mid-1970s. Finally, private and public lenders have increasingly made new flows or the rescheduling of previously contracted debt to a particular country conditional on an upper credit tranche agreement with the Fund.

As a result of these changes, it is to be hoped that the Fund will take note of the growing and increasingly respectable body of critique of its conditionality by adapting somewhat its practices. It is certainly encouraging that the Fund has engaged in some dialogue with several of its critics and given outsiders greater access to information on its relations with countries that borrow from it. Clearly more studies are required, particularly more evaluations of Fund programs after 1982 in middle-income countries and generally on programs in low-income countries. However, the knowledge and analysis already accumulated makes it feasible to pass from a phase of critical evaluation of existing Fund conditionality to proposals for constructive change through the discussion of alternatives to current practices. This would require a major intellectual effort both from the Fund staff and from its critics in academic circles as well as in governments negotiating with the Fund.

Serious discussion of an alternative form of conditionality requires, first, an explicit recognition by governments (and hopefully by the social and political groups that support or elect them) that their economy must be adjusted in the medium term in such a way that the current account deficit is not larger than the net flows of capital that other governments or international financial institutions—be they public or private—are willing to supply. Incidentally, this recognition is not only crucial for governments negotiating with the Fund but even more so for those that do not wish to turn to the Fund. Furthermore, as I have argued elsewhere (see Griffith-Jones, 1981), the need for a consistent and realistic adjustment package is equally—if not more—relevant for socialist or reformist governments than for more conservative ones.

Second, the discussion of alternative conditionality would seem to require a recognition by the Fund that its legitimate conditionality is basically related merely to ensuring that a particular improvement in a balance of payments will be achieved by some consistent and feasible set of policy changes. Focusing only on the external balance would also have the advantage of making agreements easier to reach; their definition is very straightforward, and the need for balance in the external accounts is compelling. The definition of appropriate “internal balances” (including levels of inflation, employment, and income distribution) is much more problematic. The Fund would need to recognize explicitly that the precise path by which governments wish to adjust toward a particular level of external balance should basically be decided by them; this should not only ensure that government’s objectives and philosophy are taken into account but should also make it more likely that the program will be adhered to.

New Issues

As was analyzed above, since 1982 the Fund has in certain countries (mainly the large debtors) contributed to create a market, by encouraging or even pressing particular private international banks or groups of banks to increase their lending beyond levels they may have wished to provide spontaneously. Two crucial types of question arise from this experience and from the broader context that made the Fund decide such action. First, once the acute debt crisis has been alleviated, should the Fund (and other national as well as international official institutions) continue to influence, guide, or control private financial flows? If so, how should this be achieved? Second, should the Fund also expand significantly its “catalytic” role by cooperating with official donors to help raise funding for adjustment programs which it is negotiating with low-income countries? Would it be feasible, as has been suggested (in Cassen, 1986) for the Fund (or the country’s government with the Fund’s support), while it is carrying out negotiations with a country, simultaneously to be conducting parallel negotiations with the World Bank, and other bilateral as well as multilateral donors? Such a framework would potentially allow a greater harmony among measures required for short-term stabilization and those for long-term development, which at present are sometimes in unnecessary conflict. It would also clarify significantly the expectations of additional ‘financial inflows if a low-income country has a program with the Fund, as opposed to relying on very rough estimates of likely flows that may turn out to be unrealistic, as occurs in many cases (even though the Fund and particularly the World Bank have recently begun to perform a valuable catalytic role for official flows for low-income countries).

Returning to the first, and possibly more complex question, there is an important body of professional opinion that supports the view that the Fund—as well as other official institutions, both national and international—should continue to guide or even broadly control the magnitude and distribution of private international lending, and ensure that the instruments used for this lending are such that they do not put debtors or creditors unnecessarily at risk. Such an intervention would of necessity be at the same time less specific than some of the Fund’s interventions have been since 1982, but more pervasive. The rationale for such action is based on the perception of the increased need in today’s interdependent world of defining a target or range of international liquidity which would contribute to stable, noninflationary growth in the world economy. To meet such a target or range, government institutions (both national and international) would need to take measures which would simultaneously restrict private lending during periods of excessive expansion and contribute to sustain private lending in periods of contraction. The latter could possibly (though clearly not necessarily) be linked to some guarantee, insurance, or lender of last resort facility granted either by industrial countries’ governments or by an institution such as the Fund or the World Bank.

It is noteworthy, for example, that Johannes Witteveen, former Managing Director of the Fund and currently Chairman of the Group of Thirty, has proposed (in Witteveen, 1983) such a broad initiative, by calling for the creation of a facility within the Fund that would insure bank loans against political risks in debtor countries complying with Fund programs, accompanied by a major initiative in supervision (via measures such as international reserve requirements under the Fund’s control and solvency ratios) to curb excessive credit growth in the future. Even more ambitious proposals have been made, and are summarized in Griffith-Jones, 1985. These would, for example, imply national governments’ guarantees to commercial lending within a set of current account deficit targets that the Fund would define and monitor. The likelihood of such guarantees being granted by industrial countries’ governments seems unlikely at present, but the broader principles and the analysis behind such proposals may be, or become, acceptable to a wide range of governments. Also relevant in this context is the discussion about an appropriate mix of instruments through which private financial flows would be channeled to developing countries (proposing, for example, a greater proportion of fixed interest rate lending or the introduction of quasi-equity arrangements). It would seem that at times like the present, bankers and other economic agents may be more open to debating and accepting new modalities for operation. It is interesting that many of the proposals for new lending mechanisms, new ways of dealing with the debt overhang, or new forms of interaction between the international public and private financial institutions have come from bankers.

It would be particularly valuable at present if the Fund itself took a lead in the debate on the Fund’s future relations with international capital markets, within the context of a broader range of relations that would also involve national regulatory and supervisory authorities, as well as international institutions, such as the Bank for International Settlements. The Fund’s opinion and initiatives would carry particular weight on this issue, given the prestige and experience it gained during the phase of debt-crisis management.

The particular problems of the poorest countries seem to require special attention in the context of stabilization assistance, given their unmet rights to uniform treatment in the international economic system. This has become more evident and more widely perceived as a result of the particularly damaging impact that the recent dramatic changes in the international environment have had on most of their economies. Although undoubtedly a large part of the massive problems of the poorest countries can be attributed to mistaken government policies, there is important evidence that what has differentiated individual country growth experience in sub-Saharan Africa has been the magnitude of exogenous shocks rather than domestic polices (see Wheeler, 1984); equally there is firm evidence that instability in import volumes is significantly correlated with economic growth (see Helleiner, 1984). These results strengthen the case for priority being given by the international community to the stabilization of import volumes in low-income countries, and thus for the provision of liquidity rather than long-term finance. Appropriate levels of short-term finance for low-income countries clearly would not, by themselves, guarantee improvements in their macroeconomic performance, but would make it feasible and considerably more likely.

As noted, the strongest justification for special measures for, and flexibility toward, low-income countries by institutions like the Fund is based on the principle of uniformity of treatment of member countries. It has been persuasively argued that low-income countries are at a significant disadvantage in the international economy in three key areas: the international monetary system offers them less liquidity, and notably less access to short-term and medium-term commercial bank finance; given the structure of their trade, they tend to suffer more from external shocks than other countries; and they are faced with greater difficulties in quickly adjusting the structure of their economies to such shocks.

The Fund has responded somewhat to the special needs of low-income countries, with special facilities (such as the Trust Fund) in the mid-1970s and with increased lending in the late 1970s and early 1980s. There are, however, criticisms that the response was insufficient in relation to the magnitude of the problem and there are fears that the Fund’s increased lending to middle-income countries since 1983—accompanied by potential limitations in its liquidity position—may somewhat “crowd out” Fund lending to low-income countries that would fall to levels even less appropriate for their balance of payments needs than in the past.

Many of the changes discussed above (such as orderly arrangements for continued increases in Fund quotas, the renewed issue of SDRs, and the restoration of the CFF to its previous modality of operation, as well as its possible expansion) would be particularly beneficial for low-income countries. The need for special measures for low-income countries (such as interest subsidies on Fund lending) could be justified in terms of existing precedents; circumstances today are just as critical for these countries as those that led to the establishment of the Trust Fund, for instance, in the 1970s.

A related, though somewhat different area of increased concern in recent years is the need to mitigate the negative impact on the poorest groups (in any country) of adjustment to international shocks and recessions. Increased economic interdependence and the severity of the last recession (as well as the reduced capacity of developing countries to dampen the impact of the second major recession in ten years) seem to have led to particularly damaging effects on the welfare of vulnerable groups in developing countries. Linked to this unfortunate phenomenon, there has been increased study of the link between large and problematic changes in the international environment, the need for adjustment to them, and their negative impact on vulnerable groups. A recent study sponsored by the United Nations International Children’s Emergency Fund provides clear evidence of such a link in the particular case of children (see United Nations International Children’s Emergency Fund, 1984). There is growing public concern about the deteriorating plight of vulnerable groups (and particularly children) in many developing countries, and this concern has been reflected in political circles. It is perhaps not sufficiently widely known that the U.S. Congress approved in 1980 an amendment to the U.S. Bretton Woods Agreement Act—still in effect—which requires U.S. representatives to the Fund to work for changes in Fund guidelines, policies, and decisions, and, in approving adjustment programs, to: “take into account the effect…on jobs, investment, real per capita income, the gap in wealth between rich and poor, and social programs, such as health, housing, and education, in order to seek to minimize the adverse impact of those adjustment programs on basic human needs.”

Given the current increased public and political awareness, it would seem to be an appropriate time for the Fund to begin exploring general and concrete ways in which its policy advice could contribute to maintaining or improving nutrition levels, health standards, and real incomes among the poorest sections of the population of countries with which it is negotiating adjustment programs, and to avoid—wherever possible—policy advice that may be detrimental to the welfare of those groups. The Fund itself is clearly best qualified for deciding the best way in which this could be achieved. Possible measures would seem to include: (1) research in the Fund (or in conjunction with specialized institutions) on measures to maximize welfare of poor people in the context of stabilization; (2) some change in the terms of reference, procedures, and possibly even composition of Fund missions; (3) closer collaboration with other sources of external assistance so as to mobilize additional external resources; and (4) some form of public statement, which would make explicit the Fund’s concern with—and the priority it attaches to—the need to protect vulnerable groups in the course of adjustment programs.


Marjorie Deane

I would like to confine my remarks about Griffith-Jones’s paper to the reform issues. I agree that there are two general problems: old problems that are in a very real sense dressed up in a new set of clothes; and new issues, which really present us with more questions than answers.

The framework for the multilateral coordination of policies within the context of multilateral surveillance is already in place and is about to be improved. The meetings of the Group of Five (consisting of the Federal Republic of Germany, France, Japan, the United Kingdom, and the United States), now include the Managing Director of the Fund and his participation must surely be for the good. Further, the broader Group of Ten Deputies have been meeting at intervals over the past year or so to discuss the workings of the international monetary system. These discussions will shortly conclude with the completion of a report to their Ministers.1 Now it is true this report will contain few surprises, and any prospect of exchange rate stability through a return to a fixed rate regime, or some variant of par values, is virtually dismissed. However, there is wide recognition that greater convergence of economic policies among the major countries would best promote exchange rate stability, and the report is expected to contain important recommendations on ways to strengthen multilateral surveillance. It will also review the management of international liquidity, and the future role of the Fund.

Contrary to the view of some academics, officials feel more work needs to be done on how policy changes in different countries interact with each other. But it cannot be over-emphasized that it is much more difficult to make governments aware of the international dimensions of national policy changes in a system of floating exchange rates than it was when the system was one of discrete parity changes.

The real question here, of course, is how to inject more bite into the Fund’s advice to increase its impact. I do not think the Fund can dictate to countries, as Griffith-Jones suggests, what their balance-of-payments targets should be, but its judgment on economic performance needs to be circulated beyond the traditionally narrow official sphere to bring all parties into the debate. Limiting the debate in this way has not helped to solve the main problems that have faced the international monetary system recently—the major misalignments in exchange rates that have prevailed since the early 1980s, and, in 1982, the rapidly developing Mexican liquidity crisis, which the Fund had detected more than a year before the world at large came to see its full dimensions.

In reality, the Fund has not been able to shoulder the responsibility for monitoring the new (floating) exchange rate system. If it had taken on the responsibilities given to it under the Second Amendment of the Articles of Agreement, it would have had more influence on the economic policies of the major industrial countries. Even though, as creditor countries of the Fund, these countries were, and by and large still are, unwilling to cede even a small proportion of their national sovereignty for the overall good, there is no doubt that the Fund, if it is to become more effective, must tread closer to the margin of what is politically possible. By the same token, it has to broaden its horizons. The quality of its research analysis has to be improved, as a first step; and despite the apparent overlapping of responsibilities with the General Agreement on Tariffs and Trade, the Fund has to invest much more time in, and give greater weight to, trade policies. To complement the latter, it also goes without saying that the Fund should, where circumstances warrant, place less emphasis on demand management and encourage the development of credible supply-side policies. Maybe its surveillance findings should be published, with a suitable time lag on the pattern of the disclosure of the important minutes of the Federal Open Market Committee in the United States.

The section of Griffith-Jones’s paper dealing with liquidity tries to be all things to all people, and is therefore impractical. At present there is no political will among the major countries for allocations of SDRs, nor is there any desire to promote the SDR’s attractiveness as a reserve asset. There is no hope of enhancing the role of the SDR until it is made at least as desirable as, and in practice superior to, the dollar. At this stage, it would take a fundamental decision to allow central banks to intervene in SDRs to promote its use, since interventions are the mechanism by which official settlements are made.

Until, perhaps, we see another period of prolonged weakness in the dollar, the prospect of a Substitution Account in the Fund will remain on the shelf, gathering dust. Countries are simply not willing to exchange gold and currency reserves for claims on the Fund; the fact, however disagreeable, is that shifts in the Fund’s voting power and its volume of lending to developing countries have significantly lessened the attractiveness of holding claims on the Fund above and beyond those associated with quota responsibilities. I am, therefore, forced to conclude that indexing Fund quotas, in whatever way that can be devised, is the only solution to providing the Fund with an assured, nonpolitical, source of adequate financial resources. However, given the current political realities, I am also forced to conclude that this is not a course that is likely to be followed, at least not in the foreseeable future.

What is really needed is action to encourage, even force, countries to approach the Fund at an early stage of their balance of payments problems. But again, we are faced with the almost intractable problem, at least in a multilateral concept, of how to accomplish this. Do you use inducements (the carrot approach) to encourage countries to approach the Fund early, and do you impose penalties (the stick approach) for those countries that delay (which in a sense they are doing to themselves, for the later they call in the Fund, the harsher the adjustment)?

Turning to the new issues that are raised by Griffith-Jones, it is quite plain that the Fund’s move toward closer relationships with the commercial banks cannot continue, that the banks will have to learn to go their own way in the future, with only limited help from the Fund. On a long-term basis, commercial enterprises must make their own judgments on how best to protect depositors and shareholders and uphold their fiduciary responsibilities.

No revolution will lead to a redesign of the multilateral institutions in the 1980s. Instead, we can only expect minor modifications in the structures and a gradual evolution in their practices. However, there is considerable room for improvement in their interrelationships. The cooperation between the Fund and the World Bank should be further intensified, as should that between the World Bank and the regional development banks. While we have seen much closer cooperation between the Fund and the World Bank in recent years, the two institutions are still not working closely enough together. We should be seeing more interlocking between the Bretton Woods institutions when diagnosing problems, and more regular cross-representation on missions. This does not mean the Fund should get into specialized areas such as health and nutrition; it should return to thinking more like a central monetary institution running a multicurrency reserve system, and should be making some conscious rules for that system.


  • Cassen, Robert, Does Aid Work? (Oxford: Oxford University Press, 1986).

  • Cline, William R., International Debt: Systemic Risk and Policy Response (Washington: Institute for International Economics, 1984).

  • Cooper, Richard N. “The Evolution of the International Monetary Fund Towards a World Central Bank,” background paper to Towards a New Bretton Woods: Challenges for the World Financial and Trading System, edited by Helleiner (London: Commonwealth Secretariat, 1983).

    • Search Google Scholar
    • Export Citation
  • de Larosière, Jacques,Text of Address to Council on Foreign Relations,IMF Survey (Washington), Vol. 13 (December 10, 1984), pp. 37780.

    • Search Google Scholar
    • Export Citation
  • Dell, Sidney,Fifth Credit Tranche,World Development (Oxford), Vol. 13 (February 1985), pp. 24549.

  • Dell, Sidney and Roger Lawrence, The Balance of Payments Adjustment Process in Developing Countries (New York: Pergamon Press, 1980).

  • Eckaus, Richard S.,Observations on the Conditionality of International Financial Institutions,World Development (Oxford), Vol. 10 (September 1982), pp. 76780.

    • Search Google Scholar
    • Export Citation
  • “Facility to Finance the Balance of Payments Deficit Caused by the Rise in Interest Rates,” The Economist (London, April 2, 1983).

  • Goldstein, Morris, The Clobal Effects of Fund-Supported Adjustment Programs, Occasional Paper No. 42 (Washington: International Monetary Fund, 1986).

    • Search Google Scholar
    • Export Citation
  • Goreux, Louis M., Compensatory Financing Facility, IMF Pamphlet Series No. 34 (Washington: International Monetary Fund, 1980).

  • Griffith-Jones, Stephany, The Role of Finance in the Transition to Socialism (Totowa, N.J.: Allanheld, Osmun, 1981).

  • Griffith-Jones, Stephany,Compensatory Financing Facility: A Review of Its Operation and Proposals for Improvement: Report to the Group of Twenty-Four,UNDP/UNCTAD Project INT/81/046 (Geneva, January 1983).

    • Search Google Scholar
    • Export Citation
  • Griffith-Jones, Stephany,Proposals to Manage the Debt Problem,Development Policy Review (London), Vol. 3 (November 1985), pp. 15392.

    • Search Google Scholar
    • Export Citation
  • Griffith-Jones, Stephany and Charles Harvey, eds., World Prices and Development (Aldershot: Gower, 1985).

  • Guitián, Manuel, Fund Conditionality: Evolution of Principles and Practices, IMF Pamphlet Series No. 38 (Washington: International Monetary Fund, 1981).

    • Search Google Scholar
    • Export Citation
  • Helleiner, Gerald K., “Outward Orientation, Import Instability and African Economic Growth, an Empirical Investigation,” mimeograph, 1984.

    • Search Google Scholar
    • Export Citation
  • Helleiner, Gerald K., ed., Towards a New Bretton Woods: Challenges for the World Financial and Trading System (London: Commonwealth Secretariat, 1983).

    • Search Google Scholar
    • Export Citation
  • Horsefield, J. Keith, ed., The International Monetary Fund, 1945–1965 (Washington: IMF, 1969).

  • International Monetary Fund, World Economic Outlook (Washington, May 1980).

  • International Monetary Fund, Annual Report of the Executive Board for the Financial Year Ended April 30, 1984 (Washington: 1984a).

  • International Monetary Fund, World Economic Outlook, September 1984, Occasional Paper No. 32 (Washington, 1984b).

  • Keynes, John Maynard,Proposals for an International Clearing Union,” in The International Monetary Fund, 1945–1965: Twenty Years of International Monetary Cooperation, edited by Horsefield (Washington: IMF, Vol. III, 1969).

    • Search Google Scholar
    • Export Citation
  • Killick, Tony,The Reform of the International Monetary Fund, with Special Reference to Conditionality,background paper to Towards a New Bretton Woods: Challenges for the World Financial and Trading System: Report, edited by Helleiner (London: Commonwealth Secretariat, 1983).

    • Search Google Scholar
    • Export Citation
  • Killick, Tony, ed., The Quest for Economic Stabilization: The IMF and the Third World (London: Gower Publications in association with the Overseas Development Institute, 1984).

    • Search Google Scholar
    • Export Citation
  • Lever, Harold,International Debt Threat: A Concerted Way Out,The Economist (London), Vol. 288 (July 9, 1983), pp. 1416.

  • Massad, Carlos,Implications of the External Debt for International Finance,Development (Rome), No. 1 (1984), pp. 2629.

  • Robichek, E. Walter,The IMF’s Conditionality Re-Examined,” in Adjustment, Conditionality, and International Financing, edited by Joaquin Muns (Washington: International Monetary Fund, 1984), pp. 6775.

    • Search Google Scholar
    • Export Citation
  • United Nations Economic Commission for Latin America, Adjustment Policies and Renegotiation of the External Debt, U.N. Document E/CEPAL/G. 1299 (Santiago de Chile, 1984).

    • Search Google Scholar
    • Export Citation
  • United Nations International Children’s Emergency Fund, The Impact of Recession on Children in Developing Countries, edited by R. Jolly and A. Cornia (New York: Pergamon Press, 1985).

    • Search Google Scholar
    • Export Citation
  • Wheeler, David,Sources of Stagnation in Sub-Saharan Africa,World Development (Oxford), Vol. 12 (January 1984), pp. 123.

  • Williamson, John,Keynes and the International Economic Order,” in Keyne. and the Modern World: Proceedings of the Keynes Centenary Conference, King’s College, Cambridge, edited by G.D.N. Worswick and J.A. Trevithick (Cambridge; New York: Cambridge University Press, 1983a), pp. 87113.

    • Search Google Scholar
    • Export Citation
  • Williamson, John,The Lending Policies of the International Monetary Fund,” in IMF Conditionality, edited by John Williamson (Washington: Institute for International Economics, 1983b).

    • Search Google Scholar
    • Export Citation
  • Witteveen, Johannes,Developing a New International Monetary System: A Long-Term View,1983 Per Jacobsson Lecture, summarized in IMF Survey (Washington), Vol. 12 (October 10, 1983), pp. 31921.

    • Search Google Scholar
    • Export Citation

Dr. Griffith-Jones is a Research Fellow at the Institute of Development Studies, University of Sussex, United Kingdom


The Deputies of the Group of Ten presented their report, “The Functioning of the International Monetary System,” in June 1985.