Time To Say Goodbye?
Deepak Lal
Thursday,
The Bretton Woods twins have served the world well for most of the half century of their existence. They have mediated the integration of the global economy which had fallen apart after the First World War. But are they still needed?
Developed country capital markets were shut for developing country borrowers after their widespread defaults in the 30s. The World Bank, earlier known as IBRD, thus performed an essential intermediating role in the decades after the Second World War in mobilising capital from developed countries for deployment in the Third World.
Its subsequent addition of a soft loan window in the form of IDA, merely reflected the politicisation of capital flows in the competition for political influence in the Third World during the Cold War, whose end also marks the demise of this particularly powerful motive for aid.
The various other justifications that have successively been provided for foreign aid - to fill savings or foreign exchange gaps, to alleviate poverty - have all worn thin. Thus the currently fashionable objective of foreign aid, viz. to alleviate poverty has been shown by a number of studies not to have been achieved.
While, with the full flowering of international capital markets, even the original function of intermediation between First World lenders and Third World borrowers is increasingly becoming redundant - except perhaps for Africa - and therein lies the rub.
The international government guarantees embodied in the IBRD's borrowing have allowed it to borrow at a rate somewhat lower than private agents. This allows a small subsidy on its loans over the market, which is counterbalanced by the more onerous conditions normally attached to these loans.
But the rating of IBRD bonds in the world capital market has depended also upon its record of having virtually no defaults on its loans. This has been made possible in part by the global diversification of its loan portfolio, and by the recognition that until recently Third World countries did not have free access to world capital markets, and could not therefore deprive themselves of their sole source of foreign capital.
But with the opening of the global capital market to at least the good Third World borrowers, they have no need for IBRD loans, particularly given the onerous conditions that are attached as opposed to the apolitical and relatively arms length dealings in the private global capital market.
This means that increasingly the demand for IBRD loans will be confined to those countries which the world capital market judges to be 'lemons'. This will undoubtedly damage the quality of the IBRD's loan portfolio as judged by the markets. Even the slight advantage it has had because of the government guarantees in its cost of borrowing is likely to disappear.
The role of the IMF has been under threat for much longer. Originally set up to oversee the gold exchange standard on adjustable peg exchange rates set up at Bretton Woods, this function disappeared once President Nixon closed the gold window in the early 70s and put the world on a regime of floating exchange rates, albeit, at times and places, dirty.
Since then the IMF has been rather like the Pirandello play Six Characters in Search of an Author. The 80s debt crisis, the adjustments of the transition economies of the ex-communist second world in the late 80s and the most recent Mexican and East Asian financial turmoil have each presented the IMF opportunities to find a role, albeit however temporary, to manage these crises on behalf of the international community - which in effect means the G-7 and most recently the US.
It is now hoping that with the enlargement of its quotas that it is seeking, it can become a global lender of last resort. But this is a vain hope and in its case a particularly foolish one. Walter Bagehot had defined the role of a lender of last resort in a financial panic.
It was essentially to sort out the good from bad paper in the system, allowing entities with bad paper to go to the wall but bailing out those whose prospects were sound but for the panic. But to perform this role detailed local knowledge of the relevant loan portfolio's is required.
From the recent handling of the East Asian financial crisis it is clear the IMF does not have this local knowledge. Much worse rather than being a solution it is now becoming part of the problem. It is instructive to see why, because this also holds some lessons for India's opening of its capital account which I will discuss in my next column.
In East Asia's crony capitalism there was always moral hazard for the favoured domestic borrowers, given their close links to the political authorities and commercial banks, so that they could always be expected to be bailed out if their borrowing turned sour.
In the recent crisis most of the foreign loans were private loans made by foreign banks either to local banks or businesses. Starting with Thailand there was a panic amongst these foreign lenders who sought to run.
If there had been no intervention many of these foreign lenders would have lost their shirts, as the local borrowers defaulted on their loans they were unable to pay.
Faced with this prospect, perhaps some of these foreign banks would have taken a cooler look at their borrowers long term prospects and rolled over their loans. At the least there would have been an incentive to form some form of lenders and borrowers committee to sort out the loans.
But in jumped the IMF, claiming that the run presented a systemic threat to the international financial system. Much the same pleas which was made during the long-drawn out debt crisis of the first part of the 1980s. The countries were then asked to take out IMF programs which would provide them the means to pay off their foreign lenders.
Of course the countries themselves would have to eventually service the IMF loans thereby acquired. Their taxpayers in effect had bailed out the foreign lenders at the IMF's behest.
This bailing out of foreign banks at the IMF's or US's behest - first in Mexico and now in East Asia - has created serious problems of moral hazard for foreign lenders.
Though, with the coming cleansing of their domestic financial systems that most of the affected countries are undertaking, the longstanding moral hazard facing domestic borrowers is likely to decline, there will be no such diminution of that now facing foreign lenders unless the IMF is shut down!
There are further reasons why this may also be desirable for both the Bretton Woods twins. With their original technocratic missions becoming redundant mainly because they have succeeded in accomplishing them both institutions are becoming the foreign policy arm of the West in particular the US.
As I have argued in previous columns while the promotion of the market is universally valid because of its demonstrable instrumental utility, no similar universality can be claimed for Western 'habits of the heart'.
But increasingly under the banner of 'governance', 'human rights','saving spaceship Earth', this is precisely what international institutions are engaged in.
No more poignant image of this can be provided than the posters recently
splattered all over Jakarta showing a tall white man grinning whilst a small
brown man sits at a table signing a document severely eroding his powers.
Indonesians may be forgiven for seeing this as the surrender by their Javanese
king to the very visible presence of the IMF.
This attempt to force a change in the polity of Indonesia is particularly inept, if it is remembered that Suharto unlike other Javanese Kings has been a good king who has brought untold prosperity and stability to his people.
To topple him in the name of good 'governance' would not only be arrogant but could also - as during his predecessors reign - lead to the slaughter of millions of innocents until a new Javanese kingdom is established.
This alone should give all those who are pushing their specific Judeo-Christian 'habits of the heart' cause to pause.
The author is James S. Coleman, Professor of International Development studies at the University of California, Los Angeles.
Thursday, April 9, 1998
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