What a difference a year can make. In 2009, the Spring Meetings of the World Bank and the IMF were held in the shadow of the global financial crisis. The London G-20 Summit had set out a plan to address what was widely termed the greatest challenge to the world economy since the Great Depression. The plan included the World Bank and IMF making billions of dollars available to the developing world. Today the threat of a global crisis has receded, although recovery remains uncertain and efforts to strengthen financial regulations to avoid a repeat of the crisis have so far achieved little.
Lawrence MacDonald asked CGD president Nancy Birdsall and senior fellow Liliana Rojas Suarez for their views on the world’s two largest multilateral financial institutions in the wake of the crisis and on the challenges ahead.
MacDonald: Before the crisis, there was much talk about how surges in private capital flows were making the multilateral financial institutions obsolete. This was especially true for the IMF but similar views were expressed about the role of the World Bank. Suddenly the world was looking to these institutions to help avert a financial meltdown. How did they perform, and what lessons has this taught the international community?
Birdsall: They performed well. The G-20 agreed that the IMF needed far more resources and various members provided a backstop for the IMF to shore up its lending capacity. The IMF created more flexible loan instruments, making clear it would not demand the usual conditionalities (which made sense since developing countries were in trouble due to a shock that started in the United States). For the first time ever, the IMF permitted the poorest countries to borrow without paying any interest at all for a couple of years. The World Bank and the other multilateral banks also moved quickly to make loans available, using much more of their “headroom” (the amount of loans they can make against their capital) than ever before—and thus limiting their ability to lend in 2011 and beyond without additional capital.
The lesson for the international community is that private capital flows from rich to poor countries are subject to the volatility, herd behavior, and other problems typical of all financial and banking markets. They cannot be counted on as the sole basis for development investment. Developing countries need the ballast that access to quasi-public capital from the IMF/MDBs provides. And there is a more fundamental point. In normal times, private capital tends to flow from richer to poorer countries, because the opportunities for high-return investments are greater there. But the times in financial markets are not always normal.
Rojas-Suarez: Before the recent global crisis, many governments, private sector participants and analysts had deemed the IMF to be (almost) irrelevant in helping countries either prevent or resolve financial crises. There were two reasons for this perception. The first related to the small size of IMF resources relative to the huge private flows. There was consensus that if private capital flows dried up, IMF funds would be inadequate to fill the short-term financing gap of a medium or large country in crisis. The second reason involved the appropriateness of IMF programs to deal with crises. This doubt about IMF prescriptions was based on the belief that the Fund’s response to the late 1990s East Asia crisis was poorly designed.
The global crisis presented an opportunity for the IMF to improve its credibility and demonstrate that its role as a lender of last resort was indeed central. I agree with Nancy that the Fund rose to the occasion. Backed by the huge increase in financial resources from the G-20, the IMF reacted promptly with new instruments, increased flexibility in its operations, and fresh programs and policy advice supporting the implementation of countries’ counter-cyclical monetary and fiscal policies.
Of course, it is too early to provide a full assessment. It remains to be seen whether the IMF will effectively guide policymakers through an adequate exit strategy, reversing expansionary policies at the appropriate time. But despite these remaining uncertainties, the crisis has taught an important lesson: a stable global economy needs the IMF.
MacDonald: Has the sudden flood of money distracted attention from the need for deeper reform of the governance and business model of these institutions?
Rojas-Suarez: To some extent yes. But at least in the case of the IMF, I believe that the urgent displacing the important was necessary. The key feature of the 2008–09 financial crisis was a global liquidity and credit squeeze. Uncertainty about the quality of financial assets held by international private financial institutions led to a sharp reduction in global credit and liquidity. It became essential to ensure that emerging and developing countries had access to financial resources to repay their obligations.
With enormous uncertainties about the scope of the problem, the G-20 rightly empowered the IMF with sufficient funds to provide liquidity support to emerging and developing countries. As the crisis recedes, however, the important and long-lasting governance and business model issues of the IMF are slowly taking center stage once again. I don’t expect significant advances on these issues in the forthcoming spring meetings, but I believe they will be dealt with seriously during the next G-20 meeting.
Birdsall: I agree. There is plenty of talk about governance reform, but it is mostly about decimal points of increases in the voting shares of the emerging markets. The IMF has made more progress on what might be called the business model than the World Bank. At the Bank it is tougher. The Bank is still fundamentally an institution devoted to making loans: it will take a change in incentives—not just in rhetoric—to move away from a culture of loan approvals to one where what matters is development outcomes.
Another problematic aspect of the Bank’s business model is its still-minimal program to deal with climate change and other global challenges for which the traditional country-based loan is not the right instrument. It is now almost five years since our Working Group called on the global community—the countries that own the bank—to give it the mandate and resources to address global collective action problems that matter for developing countries and poor people everywhere. This becomes more urgent with each passing year.
MacDonald: The World Bank is seeking its first capital contribution increase in more than 20 years. Would the additional funds be good for development? What strings, if any, should the United States and other potential donors attach?
Birdsall: The capital increase is relatively modest given (1) the possibility that private capital will not return to the amounts enjoyed during the 2002–07 boom and the potential for fast-growing emerging markets and many low- to middle-income countries to absorb investment and (2) the need for capital that could leverage private investments in new clean energy technologies, for example, to address climate change.
What strings? Honestly that is a tough one. Of course all the multilateral development banks (MDBs) should be pushed to avoid corruption and measure results and provide full information and be transparent. I would focus less on “strings” and more on raising the bar of expectations—for innovation (why still the cookie-cutter loan and not much help on risk sharing and risk management?), for truly independent evaluation (there is progress but why not a random sample of MDB projects each year for outside performance and fiduciary audits by private firms?), for a common agreement on procurement rules and evaluation measures across the MDBs, etc. A recent report from U.S. Sen. Richard Lugar’s Senate Foreign Relations Committee staff has good ideas.
MacDonald: In the past, U.S. decisions on capital increases guided other countries—and largely determined the total amount. But during the last round of replenishment for the International Development Association (IDA), the World Bank’s soft-loan window, the UK passed the United States as the top donor. Is the United States still in a position to call the tune?
Birdsall: Yes. The United States is no longer the biggest contributor to IDA but it is still big, and its pledges still set the bar for others.
MacDonald: There has been a lot of talk about increasing developing countries’ influence at both the IMF and the World Bank. Without getting too technical, can you update us on the state of play? Do developing countries even care?
Rojas-Suarez: With respect to the IMF, two developments were initiated during the G-20 meetings in Pittsburgh. The first was a commitment to some shift in voting power from developed countries to dynamic and underrepresented emerging market countries. However, the committed shift was very small. Voting power is related to “quotas” assigned to individual countries, and the committed shift in quotas reached only 5 percent to be implemented in 2011. The second—and in my view more important—development has been the enlargement of the IMF pool of funds for dealing with crises (the IMF’s New Arrangement to Borrow or NAB) through commitments from a number of countries, especially large emerging countries such as China and Brazil. Although these commitments do not provide for any formal increase in voting powers, increased financial participation can lead to a de facto increase in participation in governance.
In my view, large emerging market economies, and especially those in the G-20, care more than other developing countries about participating in the decision-making of multilateral institutions. After all, the emerging power of countries like Brazil and other BRICs lies in their increased capacity to influence international negotiations. Other developing countries’ interest in influencing multilateral decisions is less clear.
Birdsall: It is good that the World Bank now explicitly recognizes that it is different from the IMF and that this should be reflected in governance arrangements. Since the bank’s mission is development, and its clients need to have substantial influence if it is to be effective, a country’s share of global GDP is not an appropriate primary determinant of votes and shares. At the spring meetings, the bank’s member countries are likely to agree to increase developing countries’ shares from about 44 percent to 47 percent. But 50 percent that matters, not the difference between 44 percent and 47! This is not pie in the sky: developing countries have held 50 percent of the votes at the Inter-American Development Bank for more than a decade. With half the votes, developing countries can in principle block policy changes they don’t like.
Probably more important than decimal points of voting shares is the selection process for the leaders of these important international institutions. My own view is that double majority voting would ensure that the United States and Europe together would still have an effective veto on candidates they didn’t want—but so would various coalitions of low- and middle-income countries. That would protect the majority while providing minority rights.
MacDonald: Both the World Bank and the IMF have made efforts to support an international response to climate change. The World Bank has stepped up lending for clean energy and is serving as the host institution for the Clean Technology Fund. And IMF managing director Dominique Strauss-Kahn asked for a staff paper outlining how so-called the Special Drawing Rights or SDRs (the Fund’s de facto currency) could back bonds to fund responses to climate change. But both institutions have encountered suspicion and criticism, and hopes for a global accord were badly disappointed at the Copenhagen climate summit last December. In this situation, can the World Bank and IMF be a meaningful part of the search for a solution or is their talk about climate little more than posturing?
Birdsall: The IMF has enough on its hands dealing with the inherent market failures associated with financial flows! The World Bank has to be a meaningful part of the search for a solution. Its Climate Investment Fund is already playing a role, although it’s way too small given the magnitude of the problems.
MacDonald: What is the single biggest challenge you see to the Bank and the Fund, respectively?
Birdsall: For the World Bank, reforming the leadership selection process is a very important. I'm not sure it's the biggest challenge but it's an area where the current president, Robert Zoellick, could make an historic contribution. Zoellick has been a good president, calming the waters after the upheaval surrounding his predecessor. His first five-year term will be completed in the middle of 2012 (and he may well get a second term). He could use the next two years to put in place the mechanisms for selecting a highly qualified successor in a manner that is open, transparent, and merit-based, without regard to nationality. (I’d like a double-majority approach, but that is a good means not an end in itself.) A 2007 CGD survey of the global development community found widespread support for such reforms, including among development experts within the United States. This is the single most important challenge for the bank and the single most important thing that Mr. Zoellick can do to establish a lasting, historical legacy.
Rojas-Suarez: For the IMF, the biggest challenge is to consolidate its credibility gains by actually playing a major role in systemically important issues. While the current crisis has helped the Fund to show that it has the capacity to effectively support individual countries’ efforts to deal with major financial shocks, strengthening its role in avoiding and resolving unsustainable global imbalances is still a crucial pending task. The role of the IMF in facilitating such cooperation is vital for the stability of the global economy.