Bring Back Bretton Woods
It's time for a rebirth of the world's top financial institutions.
In their relatively short lives, the reputations of the so-called Bretton Woods institutions have pivoted 180 degrees — from central and powerful to peripheral and ineffective. The International Monetary Fund, critics say, goes soft on the most powerful and is downright autocratic with the weak. The World Bank has failed to reduce poverty and even gotten bungled up chasing a few false prophets of economic growth.
There is something to these critiques. Yet, after spending years on either side of 19th Street in Washington as part of the operations of these two financial institutions, I have grown persuaded that together the IMF and the World Bank represent our best hope for global economic governance. And as such, it’s time for them to return to center stage. With all their limitations, these institutions remain the only foundation for the hope of a truly multilateral system of international economic relations. Their deficits of effectiveness and legitimacy largely owe to the unwillingness of their leading members — the rich countries that have been part of the various G-something clubs — to live up to the standards of multilateralism upon which both were founded. It is external direction from nonrepresentative groups of countries that has fed the impression that the current international economic system fails to serve the interests of all its members evenly. This lack of trust undermines international cooperation and needs repair.
In recent years, calls for reforms of these institutions have grown; the global financial crisis should have made changes imperative. But the decisions made by world leaders have fallen much short of what is necessary. Nearly three years after the outbreak of the gravest crisis in eight decades, its root causes have been left unaddressed. Little has been done to tempter the risk-taking attitude of global banking and finance. International imbalances remain formidable due to uncoordinated national economic policies. Markets could still be subject to major shocks. Multilateral cooperation, while initially successful in avoiding the precipice, has largely returned to predictable inconclusiveness. And even though changes in the governance of the IMF are in the making, they are merely cosmetic in the scheme of things and will not alter the system at its core.
World leaders are nowhere close to accepting the lesson their forefathers learned in the 1940s: that a stable and dynamic world economy needs a multilateral framework that provides legitimate and effective institutions where countries coordinate policies and implement common rules. That’s why, for the last two years, my like-minded colleagues in the Group of Lecce — a think tank that is active in the area of global governance issues — and I have been arguing for more global integration. The proposals sketched below reflect the ambition for an authentic multilateralism whereby the Bretton Woods institutions become a single, universal system of multilateral financial relations.
Reforming the international monetary system is necessary for the world economy to recover balance and restore growth. One of the major contributors to the economic crisis was the rise in global imbalances — the hyperpolarization between creditor and debtor countries. Yet now, months after the recession is officially over, there are still no incentives for large creditors (such as China) or debtors (such as the United States) to reduce their respective loaning and borrowing. Usually, the burden of adjustment falls on the deficit countries, as Greece and Iceland can attest. Surplus countries such as China and Germany, meanwhile, feel neither the responsibility nor the pressure to adjust. But surpluses are merely a mirror image of deficits: If there is an element of irresponsibility from countries running protracted deficits, there is an act of free riding from those that accumulate surpluses thanks to those who overspend.
The current international reserve system is equally deficient. Countries fearing erratic exchange-rate fluctuations and capital flows seek to accumulate foreign currency reserves in hopes of smoothing out the ebbs and flows of growth. But while this may be individually rational, it globally contributes to imbalances. Much of this recent debate has revolved around forcing China to appreciate the renminbi to reduce its surplus.
But such questions address only one manifestation of the problem. It would be far better to radically correct the entire global financial system, rather than tinkering at the margins. First, countries should agree on a mechanism whereby both deficit and surplus countries are responsible for adjusting their structural imbalances. Surplus countries would be required to invigorate domestic demand, thus reinjecting stimuli into the global economy, while deficit countries would reduce their absorption. The correction of these external imbalances would take place through both import contraction and export expansion. If both sides of the imbalance were involved in making changes, the adjustment cost for deficit countries would be lower and its negative impact on global growth reduced.
Second, as the adjustment proceeds and exchange rates settle around values consistent with more balanced external positions, countries should establish an exchange-rate target zones arrangement, whereby the exchange rates of the major currencies would be allowed only limited fluctuations around target values. The arrangement would help stabilize market expectations and commit countries to implement policies that are consistent with stability. In the event that countries disagreed on adjustment burden sharing, the exchange-rate zone targets could be revised through negotiations.
Third, the IMF should promote the use of the "special drawing right" — the artificial currency created in 1969 to supplement countries’ official reserves. The IMF should be allowed to govern the supply of special drawing rights, thereby managing global liquidity. Promoting the use of the special drawing right as international money would reduce the incentives for countries to run external surpluses for the purpose of accumulating dollar or other reserves and would counter the tendency of reserve-issuing countries to resort to excessive money creation. Overall, it would induce countries to limit inflationary and deflationary pressures.
These new mechanisms must be accompanied by global governance reforms. Decisions impinging on the lives of peoples worldwide should no longer be taken by exclusive clubs in which the countries sitting at the table have no obligation to consider the views and interests of those not included. Decision-making bodies should be sufficiently agile to operate effectively, but they should recognize the right to a voice for all members of the international community.
The IMF remains the only legitimate international financial institution for this purpose. The current composition of its executive board and ministerial committee (the International Monetary and Financial Committee, IMFC), which are responsible for its conduct, mean that just 24 members represent the 186 countries that make up the IMF. Although some progress is being made, in particular by giving more voting power to members from the emerging markets, there is more to be accomplished. The two governing bodies’ sizes should be reduced to 20 countries, there should be a single chair for Europe and no single-country constituencies, and no veto power should be granted to any member. Backed by the whole international community, a reformed IMFC would replace the illegitimate "G" clubs and serve as the council forum where ministers and governors coordinate national policies and define strategic directions for international finance. Policy coordination would preserve the new exchange-rate arrangement and facilitate external adjustments. The IMFC would coordinate all the international financial policy agencies (such as the standard setting and regulatory bodies) and hold the IMF’s executive board accountable for its performance.
An effective and legitimate IMF also requires a strong and independent executive board empowered to act as a filter between the interests of individual members and the objectives of the IMF’s membership as a whole — much as the European Commission is meant to do within the European Union context, where it acts as "the only organization that is paid to think European," as its secretary-general, Catherine Day, put it. This change would make the board authoritative, collegial, capable of taking decisions independently of members’ influence, and effective in controlling management. The board should ensure that the IMF delivers the highest standards of competence and integrity, and should protect the staff’s prerogative to exercise autonomous judgment with no special regard for or subjugation to individual members — what it is not able to do today.
Finally, the current dual role of the managing director — as chair of the executive board and CEO of the IMF — weakens board effectiveness. Because of duality, the managing director chairs the very body to which he should be accountable as head of the organization. No wonder board directors refrain from criticizing too much; they do not want to antagonize their boss. Such intrinsic board weakness would be resolved by having member governments select the chair of the board (through objective and transparent criteria) and by having the board select the head of the organization — who would then report to the board.
Such reforms would introduce binding rules and greater rigor for all countries. This new system would better protect the interests of the smaller and poorer members of the international financial community. And for this very reason, such reforms would likely face strong resistance from the largest and richest countries, which would have to sacrifice some of their power for the greater good.
With two years gone by since the global financial crisis officially ended, the world economy is still plagued by formidable disequilibria. Addressing these trouble spots and preventing their recurrence requires a strong and genuinely multilateral governance framework, providing rules by which all countries should feel obliged to abide in the interest of their peoples and a place where countries consider the impact of their policy decisions on one another and behave accordingly. The IMF is far from that ideal — but it’s also the only body that can get us there.