A Blue Print for IMF Reform*
The International Monetary Fund may need a boss, but it needs a new mission
even more
By Allan Meltzer and Jeffrey D. Sachs
The International Monetary Fund and the World Bank, set up respectively to
preserve global financial stability and to promote economic development in
poor nations, have made important contributions in the past half century.
But both institutions require deep reforms. In 1998 the U.S. Congress
created the International Financial Institution Advisory Commission to
advise on the kinds of changes that were needed. The commission, on which
we both served, issued its report yesterday.
Our report steers a course between the growing number of critics calling
for the abolition of these institutions and the dwindling number of
officials who still believe that tinkering is enough. The U.S. Treasury,
the leading shareholder of both institutions, has now called for
fundamental reform. Our report strongly supports Treasury Secretary
Lawrence Summers in his call for the IMF to refocus its lending on
emergencies rather than long-term finance. In fact, we urge the IMF to get
out of long-term development finance altogether.
The IMF was created to preserve stability in the world's currency markets,
in part by making short-term emergency loans to countries whose currencies
came under attack. The idea was to help preserve a global system to stable
exchange rates. When exchange rates between the major currencies became
flexible and market-driven in the 1970s, part of the original rationale of
the IMF was lost.
The fund soon took on other tasks. In the 1980s it tried to bail out
developing countries that had gone bankrupt after a burst of over borrowing
in the 197s. But it took far too long to recognise that bad loans made
between poor-country governments and private creditor needed to be
cancelled rather than simply rolled over or paid off by IMF and World Bank
loans that in turn became unplayable.
Massive Corruption
In the early 1990s, the IMF was given the lead in Western assistance to
Eastern Europe and the former Soviet Union. In part because the IMF turned
a blind eye to massive corruption in Russia and its neighbours, its record
in the transition process has been mediocre at best.
In the second half of the 1990s, the IMF organised unprecedented rescue
packages for financially beleaguered countries in Asia, Eastern Europe and
Latin America, raising several questions: Why had the IMF failed to foresee
those crises? Why had its "remedies" failed to prevent deep recessions in
the affected countries? Did the IMF own lending packages create
expectations of further bailouts, thereby encouraging speculation? Why did
countries that shunned IMF advice, such as Malaysia, recover along side
those with IMF programmes?
Our commission found that the starting point for reform is for the fund to
return to its original purpose: short-term, emergency lending. We also
urge that as the IMF cease its long-term lending operations in Africa and
other poor countries, it should simply cancel the IMF loans owed by the
poorest countries (, as should other creditors such as the World Bank and
donor governments, including the U.S.)
While the IMF's role as a quasi-lender of last resort is still needed in
emergency circumstances, this role needs fundamental restructuring. The
expectation of future IMF bailouts actually helps to fuel the volatile
short-term capital flows that have played a key role in recent crises.
Therefore, a requirement should be phased in that member governments
seeking emergency IMF loans must satisfy preconditions designed to prevent
future crises.
We identified four such preconditions. First, governments should ensure
the adequate capitalisation of domestic banks, so the IMF won't have to
bail them out. Second, developing countries should allow foreign banks to
enter the market, in order to increase the capital base and efficiency of
the banking sector and to reduce corruption. Third, member governments
should commit to fiscal standards so that IMF funds do not merely feed
their profligacy. Fourth, governments should guarantee much more timely
and accurate financial information.
We recognise that rare emergencies on a global scale might still arise in
ways not foreseen today. Thus, if a truly global financial crisis
explodes, the IMF should retain freedom of manoeuvre even when key
countries do not qualify for loans. Other hallowed traditions of lender-of-
last-resort operations should also be observed. IMF lending should be
short-term; not stretching out over years or decades as it does now. The
loans should be at penalty interest rates, so that governments would come
to the IMF only as a last resort. And the IMF should demand priority over
all other creditors. Private creditors would have to take their lumps if
they over lend to sovereign borrowers.
The IMF would remain an integral part of the global system, but in a very
different form. Rather than routinely lending to 50 or more countries,
there might be a handful of emergency operations in a year. The IMF would
stop trying to micromanage the governments of the developing world. The
terms for emergency borrowing would be based on pre-qualifications, rather
than conditions imposed after the fact. Member governments would still
consult the IMF about macroeconomic and financial policies, but these
consultations would be advisory. And of course the IMF would continue its
useful work of standardising and publishing global data.
The World Bank needs equally dramatic changes. The commission found that
the World Bank, even more than the IMF, had failed to adjust to fundamental
changes in the world economy. As a result, the bank has fallen far short
in the basic goal of combating global poverty.
When the World Bank opened its doors in 1946, international financial flows
were negligible, and the new bank aimed to compensate for the absence of
private-sector finance. Today, by contrast, foreign direct investment is
the key fuel of development finance, and the World Bank is a small player
in cross-border flows to developing countries. But the World Bank
persists, amazingly enough, in focusing most of its lending on a dozen or
so of the developing countries-including Argentina, Mexico, Brazil and
China-that have ample access to private capital. In the process the bank
falls disastrously short where it is really needed, in helping the poorest
of the poor.
Stop the Pretence
The commission's most important recommendation is that the World Bank phase
out its lending operations to the richer developing countries and those
with ample access to private capital, thereby refocusing its efforts on the
poorest countries. It should cancel its claims against the highly indebted
poor countries. For the future, the World Bank and the regional
development banks should stop the pretence of "lending" for poverty relief
and instead provide grants. The development banks should use subsidised
loans only to support basic institutional reform.
With its banking function largely supplanted by private capital flows, we
suggest renaming the World Bank the World Development Agency. To improve
effectiveness and reduce corruption, its grants should be provided in
return for actual delivery of services, not for mere promise. Payments
would be made only upon successful performance, verified by outside
auditors. The primary responsibility for country-level assistance should
lie with the regional development agencies, which are closer to the local
realities.
Impoverished countries are often trapped not just by bad policies or a lack
of funds, but also by lack of scientific knowledge. New technological
approaches are needed to battle malaria, adjust to climate change and
increase tropical food production. The new World Development Agency should
use much more of its income to promote research in these areas-often in
partnership with private companies-rather than relying on traditional
lending programmes that don't focus on the needs of poor countries.
Each year U.S. foreign assistance to the poorest countries amounts to only
about $6 for each U.S. citizen. Americans and their representatives in
Congress should, and would, support significant increased aid if they were
assured it would be used effectively. The commission's bipartisan
proposals seek to restore the efficacy of the international institutions,
providing the basis for a renewed U.S. consensus on this country's role in
support of global financial stability and the struggle against poverty in
the world's poorest nations
*The World Street Journal Europe, Thursday, March 9, 2000
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