Forum for Economic Policy
Do We Still Need the IMF and the World Bank?
The concept of conditionality has long been at the centre of criticisms about the International Monetary Fund (IMF) and the Word Bank. More recently, concerns about political influences on the institutions’ lending decisions abound, and so do worries about the unclear separation of tasks between the Fund and the Bank, governance issues, and their lack of transparency. The IMF, finally, seemed to be running out of clients until the recent crisis.
Arguably, many good things are done at the IMF and the World Bank. The institutions provide international public goods such as high quality research, valuable databases, and technical assistance to its member countries. However, since 1944 – when 45 countries gathered in Bretton Woods and agreed to establish the IMF and the World Bank – many things have changed in these institutions. Some of these changes are for better, some for worse. The IMF initially was responsible for promoting balance of payment stability and supervising economic policies of its member countries. The World Bank was chartered to promote long-term development of its members.
Unclear Responsibility
Today, the division of labor between the institutions is rather blurred. After the collapse of the fixed exchange rate regime in 1973 the IMF started to grant long-term loans, over time, increasingly for structural adjustment. It became a development institution that it was not meant to be at Bretton Woods. The World Bank increasingly provided budget support rather than financing specific projects. As a consequence, two institutions are being involved in the same business. In the beginning of the 1980s, countries could for a short time choose between the IMF and the World Bank when applying for money. Obviously, this was not in the interest of the institutions. To avoid competition, the Fund and the Bank started to cooperate on lending decisions. Today, consequently, Fund missions usually involve Bank staff, and the other way round. This practice is inefficient and ineffective. None of the institutions has to take full responsibility for the outcome of the credit programs, distorting incentives. There are two options. First, the Fund and the Bank could compete for the best concepts rather than forming the lending cartel that they represent today. Second, they could be merged into one institution. If they act as a cartel anyway, overhead could be spared.
The Principle of Conditionality
Not easy to imagine today, but when the IMF and the Bank have been founded, no one had in mind giving them the power to impose detailed conditions on their member countries. However, over time, conditions attached to the institutions’ lending programs became increasingly detailed and numerous. Initially, recipient countries were required to comply with a small number of macroeconomic conditions. Today, conditions are as detailed, as, for example, guiding the recipient country to close certain branches of a mal-functioning bank at a defined point in time. Reform packages intervened in almost all public and social spheres of the recipient countries by the end of the 90s.
Detailed and numerous conditions are arguably in the interest of the institutions’ bureaucrats. By being able to ask for tough conditions on loan programs they exercised their bureaucratic power and increased their prestige. Clearly, however, it is not the task of an international organization to alter a country’s domestic political equilibrium. National governments, nowadays most of them democratically legitimized, are responsible for their own economic policy; not the IMF or the World Bank. Reform programs not only affect the politics of the country at the macro-level but directly and severely interfere in its citizens’ lives. When reforms fail, the citizens have to suffer from negative consequences caused by a program, not the international institutions.
Most importantly, conditions imposed by the IMF and the World Bank have not been a story of success. The IMF has been blamed for worsening macroeconomic conditions of program countries by supporting inappropriate conditions – in particular when dealing with the Asian Financial Crisis in the late 1990s. More generally, empirical research shows that only about 50 percent of the Fund’s conditions are implemented and that they do not substantially contribute to promoting economic growth if implemented. Also, only about 60 percent of the World Bank’s conditions in its structural adjustment programs have been implemented. Many recipient countries remain as vulnerable to future crises as before the programs. They become users of the IMF’s and the World Bank’s money on a permanent basis. Recidivism is frequent.
Arguably, economic crises are often caused by poor economic policies and weak institutional environments. Without external assistance, countries under crises would have no choice but to carry out painful but necessary reforms. The rescue packages offered by the IMF and the World Bank alleviate the problem and reduce pressure to reform. Necessary reforms become less not more likely. This is aggravated by the fact that the IMF and the World Bank do not rigorously punish non-compliance with their conditions. Excluding countries from the programs of the institutions for a certain pre-announced time is not in the interest of the institutions – it limits their discretionary leeway. Conditionality loses credibility and thus one of its main potential functions, the provision of guarantees for investors regarding pre-announced policies.
The World Bank has learned from its mistakes. The IMF has not. In recent years the concept of ownership dominates the Bank’s lending considerations. Conditions are carefully considered and became less intrusive. The IMF also subscribed to reducing the number of conditions, in its 2002 Guidelines on Conditionality. However, while these guidelines constitute an important reform of conditionality in theory, the Fund talks the talk without walking the walk. While the institution, overall, subscribes to a new policy of ownership, where conditions must be included only when necessary to achieve the aims of the programs, IMF staff on the ground does not go along. As a consequence, the average number of conditions has not been reduced in recent programs, according to the evaluation of the Fund’s Independent Evaluation Department.
The IMF and the World Bank are Dominated by their Major Shareholders
The G7 countries’ voting share in the IMF’s and the World Bank’s Executive Boards exceeds 40 percent. The USA alone holds about 17 percent of these shares. Clearly, thus, the institutions’ policies reflect the political interests of a few developed countries. Recent studies, indeed, do show that political proximity to the G7 countries – the main shareholders of the IMF and the World Bank – is rewarded by the Fund and the Bank alike. Closer allies of these countries receive more programs, larger loans, and fewer conditions. Friends of the United States, in particular, receive IMF programs with fewer conditions, on average, and in particular at election time. Even the economic forecasts of the IMF are biased in favor of friends of the United States. The Managing Director of the IMF is always European; the World Bank President is a citizen of the United States. Citizenship rather than competence is important to get two of the most important jobs in the international arena. While recent quota changes are meant to address the obvious inconsistencies between voting power at the Fund and the Bank and importance in the world economy that arose since the 1940s, real reform is unlikely. Real reform would require those to give up some of their power who decide upon the content of reform. More than window-dressing can hardly be expected. In addition, reducing the influence of the G7 might come at a cost. It might well be that the rich countries are only willing to finance the Fund and the Bank because they know that they can influence the institutions according to their political interests. Without such possibility, Fund and Bank might lose their financiers. The choice might not be between politically influenced institutions and institutions exclusively acting according to their economic mandate, but between politically influenced organizations and no organizations at all, as the economists Axel Dreher from Goettingen, Jan-Egbert Sturm from ETH Zurich, and the political scientist James Vreeland from Yale argue in a recent article.
Do the Institutions Run out of Clients…?
The World Bank allocates large parts of its credits to countries with easy access to private capital. This has been among the most important criticisms raised by the so-called Meltzer Commission, the International Financial Institutions Advisory Commission (IFIAC). According to the IFIAC, the World Bank provided 70% of the credits for only 11 countries between 1992 and 1999. All of these countries had easy access to private capital markets, contradicting the mandate of the Bank. It seems that the Bank behaves like a bank and provides money mainly to middle income countries able to provide guarantees that the money will be repaid. This must end. The Bank has to focus on the poorest countries and stop lending to countries with middle income. Rather than contributing to the indebtedness of the poorest countries, the Bank should provide grants rather than loans to those poorest countries. It should, moreover, withdraw from areas where well-developed regional development banks are ready to take over. In Latin America, Eastern Europe and Asia, these development banks are better suited to fulfill the needs of the poor. These regional banks are not dominated by Western countries; their policies are less likely to be dominated by political rather than economic concerns.
While demand for the Bank’s money still prevails, the IMF seems to be running out of clients. Until the recent financial crisis, the number of countries borrowing from the Fund continuously decreased over time. Countries in Latin America turned against the Fund mainly for political reasons. Countries in Asia piled up huge amounts of foreign reserves in order not to have to turn to the Fund for another time, should a crisis occur. Industrialized countries did not borrow from the Fund from the end of the 70s until recently. The IMF seemed to be in a crisis of purpose. As it has always been in the past, however, the IMF showed to be responsive to the needs of the markets. It proposed to be involved in a new Sovereign Debt Restructuring Mechanism (but failed with this proposal). It proposed to be more active in multilateral surveillance (and has been successful).
In order to stay relevant after the resolution of the recent crisis, substantial reforms are necessary. Fund and Bank have to be more transparent to allow external researchers evaluating their policies and projects. While the IMF has recently made a big step and started to share its conditionality database with researchers on request, the Bank is still reluctant to share its project evaluation data. An institution asking for transparency and good governance from countries borrowing its money has to provide the same good governance and transparency with respect to the international tax payers financing its operations. Deeds have to follow words. IMF staff has to comply with the new conditionality guidelines. A real reform of quotas (and thus voting rights) is necessary. The World Bank has to withdraw from middle income countries.
The institutions could remain important providers of public goods. In addition to providing data, advice, and knowledge, the IMF could provide two main facilities. One facility would be available for countries with sound policies that have been hit by exogenous shocks, experiencing a crisis largely beyond their control. These loans could be subsidized. (The Fund’s new short-term liquidity facility for well-performing countries is a partial step in this direction.) The second facility would provide money to countries independent of their policies, but only when there is the risk that the crisis spreads to other countries, in other words when externalities are involved. These funds should be provided at an interest surcharge, rather than a subsidy. Countries with bad policies and no systemic influence should not receive any loans at all.