USA: Between Revolution and Reform - The Meltzer Commission's Vision

Publisher Name: 
Financial Times

The Meltzer Commission's vision for the IMF and the World Bank moves in the right direction but is too simplistic

The "report of the international financial institution advisory
commission" sounds so innocuous. It is not. In the current US debate, it
will be explosive. The question is whether it will end with pure
destruction or efficient replacements for the International Monetary Fund,
World Bank and regional development banks of today.

The background to this commission was the 1998 Congressional debate on
whether to authorise Dollars 18bn in additional funding for the
International Monetary Fund. The question to be addressed was a
politically vexed one: the role of the international financial
institutions now.

These were created, under US influence, more than half a century ago.
Their aims were to promote liberalisation of controls on trade and foreign
exchange, to support a system of fixed exchange rates and to advance
postwar reconstruction and longer-term economic development. On most
measures, they have been a staggering success. As the report notes: "In
more than 50 years, more people in more countries have experienced greater
improvements in living standards than at any previous time."

Yet the world has changed. Private capital flows dwarf official lending;
floating exchange rates have replaced the adjustable pegs of the old
Bretton Woods system; and the imperatives of the cold war have gone. The
latter have been replaced in the US by a growing indifference to the rest
of the world.

The commission's recommendations can then be judged from four different
perspectives. The first is whether it has constructed a new domestic
consensus on how and why to assist developing countries. The second is
whether its broad conceptions make sense. The third is whether its
detailed proposals are equally sensible. And the last is whether its
impact will be desirable.

On the first of these points, no consensus has emerged. There is, instead,
a majority report signed by eight members and a dissent signed by four.
Since the commission, chaired by the monetarist Allan Meltzer of
Carnegie-Mellon university, contained a mixture of conservatives and
liberals (in the US sense of these words), this division is not that
surprising.

Turn then to the second issue. The majority report, for all the tensions
within it, embodies a more or less coherent view of how these institutions
should be restructured. It has the following core elements.

  • The International Monetary Fund should restrict its lending to the
    provision of short-term liquidity to countries in financial difficulties.

  • Except in unusual conditions, loans would be made only to countries that
    have met preconditions for financial soundness.

  • The World Bank should focus its efforts on low-income countries that
    lack access to capital markets.

  • Country and regional programmes in Latin America and Asia should be the
    primary responsibility of the area's regional banks.

  • The IMF, World Bank and regional development banks should write off all
    claims on highly indebted poor countries "that implement an effective
    economic development strategy".

  • The US should be prepared to increase significantly its budgetary
    support for the poorest countries.

At a very broad level, these suggestions make sense. The ideas that there
should be a much clearer dividing line between the functions of the
institutions, that the IMF should focus on financial soundness and that
the development agencies exist to do what the market will not - or cannot
- do are all perfectly reasonable. Note too what the majority have not
called for. They have not demanded the abolition of what remain, on
balance, valuable international agencies; they have not suggested that the
lender of last resort function is unnecessary; and they have not opposed
aid to poor countries. This is definitely a move by the Republicans
towards the centre-ground.

So is the report good news? "Up to a point" is the answer. The devil is in
the detail and many of the details turn out to be very worrying. Consider
just a few of many examples.

On the IMF, the notion of pre-qualification for emergency assistance is
far more difficult than the report recognises. What happens if the
country's standards slip? How is the IMF to avoid being blamed for
triggering a crisis by pointing out this fact?

Then there is tension between the intrusive pre-conditions the report lays
down - freedom of entry for foreign financial institutions being one
striking example - and its concern for national sovereignty. Similarly,
the report declares that "IMF lending should not be used to salvage
insolvent financial institutions, directly or indirectly". But how is this
to be prevented without the very conditionality it rejects?

Again, the document takes the parallel between a lender of last resort for
states and for financial institutions too far. The question in the case of
countries is always whether they will be in a position to repay. That
depends on their policies, which is why macro-economic conditionality is
inevitable.

Moreover, the question of what is to be done in those systemically
important countries that do not pre-qualify is left obscure. Assistance is
not ruled out, but how it is to be offered in such cases is essentially
unexplained.

Turn then to development assistance. Why withdraw virtually all assistance
from middle-income countries that are able to attract capital inflows?
They, too, are very poor compared with the high-income countries. Much is
made in the report of the annual subsidy cost of up to Dollars 31bn a
year. But that is just 0.15 per cent of the national incomes of the
high-income countries. Why worry about that?

Again, why cut back the World Bank's responsibility in Asia and Latin
America? True, the institution is imperfect, but it has wider knowledge
and offers a better cushion against political pressures. And too much is
made of the need to move to grants. There is a strong case for continued
lending, because it forces some financial discipline on borrowers.

In the end, however, the biggest question is the fourth: will this report
lead to more effective assistance to the poor and a more stable global
financial system? Somehow, I doubt it.

It is impossible to defend the status quo without qualification. There
have been too many disasters. But the question is whether changes should
be gradual or revolutionary. The current arrangements, for all their
faults, are not bad enough to require a revolution. What is needed instead
is to shift the institutions in the directions outlined, but slowly and
with care. This may not be as exciting. But it is more sensible.

AMP Section Name:World Financial Institutions
  • 194 World Financial Institutions