The International Monetary Fund and the World Bank in a Globalized World

Table of Contents

List of abbreviations

Index of Figures and Tables

1. Introduction

2. The International Monetary Fund
2.1 General Information
2.1.1 Facts and figures
2.1.2 Foundation
2.1.3 Governance Structure
2.1.4 Distribution of quotas and votes
2.2 Areas of responsibility
2.2.1. Lending
2.2.2 Economic surveillance
2.2.3 Capacity development

3. World Bank
3.1 General Information
3.1.1 Facts and figures
3.1.2 Foundation
3.1.3 Governance Structure
3.1.4 Distribution of Votes
3.1.5 Funding source
3.2 Areas of responsibility
3.2.1 International Bank for Reconstruction and Development
3.2.2 International Development Association

4. Case Study: Aid package for Ireland

5. Criticism

6. Conclusion

List of References ..

List of abbreviations

Abbildung in dieser Leseprobe nicht enthalten

Index of Tables and Figures

Abbildung in dieser Leseprobe nicht enthalten

1. Introduction

“We must create a kind of globalization that works for everyone and not just for a few.” – Nestor Kirchner, former Argentinian president.¹

There is no doubt that the process of globalization, defined as the gradual move- ment towards a more intertwined world, has enriched our personal life economi- cally and culturally. We benefit from international cooperation, free trade, innova- tion, a broader knowledge, and facilitated communication and generally, we are offered more possibilities to shape our life as it may best please us. Nevertheless, global interdependence implicates fierce competition and therefore a stronger di- vide between rich and poor. Moreover, increasing environmental pollution and the violation of human rights are accepted, just to push forward economic success. In order to solve negative side effects caused by globalization, several associations have been established over the years. Among these, there is for example the Or- ganisation for Economic Cooperation and Development (OECD), the World Trade Organisation (WTO), the United Nations (UN), the International Monetary Fund (IMF) and the World Bank.

In this seminar paper we will focus on the two latter institutions with the intention to illustrate their significant influence on prosperity and development. Even though the IMF and its “twin institution” are independent bodies that do not al- ways collaborate in current projects, their responsibilities often overlap as they pursue the same goals: reducing poverty, supporting economic growth and global trade as well as stabilizing the international financial system. To maintain a clear overview about the organization’s differences, they will be described separately in the investigation. After the explanation of their functionality, the ideal procedure of an IMF aid-package will be briefly illustrated based on the example of Ireland. We have chosen this particular project for two reasons: Firstly, we – as German citizens – are more effected by incidents happening within the euro zone as Ger- many represented one of the largest financial aid suppliers in times of the Europe- an crisis. Secondly, the Irish bailout program has already been fully completed which allows us to present a broad outline from the early stages to the still ongo- ing consequences. Afterwards, we will look at the IMF and the World Bank from a more critical point of view because today, there is a large number of existing opponents that blame the institutions to even worsen a country’s situation. Even- tually, we want to analyze the fulfillment of their role in a globalized world.

2. The International Monetary Fund

2.1 General Information

2.1.1 Facts and figures

The International Monetary Fund is one of the autonomous “United Nations Spe- cialized Agencies“1 with its headquarter located in Washington, D.C. in the US. Today, approximately 2,600 workers from 147 different countries daily pursue the financial institution’s objective. The IMF, hereinafter also called “the Fund”, of- fers a broad range of services to its 188 member countries, including surveillance, the granting of credits and technical assistance or trainings.² In return, the Fund introduces obligatory macroeconomic policies in consultation and negotiation with the country’s government officials.³ Moreover, the IMF is one of the largest holders of gold, having 90.5 million ounces in stock.⁴

2.1.2 Foundation

In July 1944, the USA invited 44 delegates of the Allied Powers⁵, thus excluding Germany, Italy and Japan, to the Mount Washington Hotel in Bretton Woods in New Hampshire. The purpose of this meeting was to discuss how economic de- velopment, trade and capital investment could be boosted after World War II.⁶

This reunion, called “the United Nations Monetary and Financial Conference“ ¹, went down in history as the hour of birth of the Bretton Woods System as well as of the IMF and the International Bank for Reconstruction and Development (IBRD), both particularly founded to execute the system’s supervision.

More than one year later on December 27th, 1945, the IMF was officially consti- tuted.² Its primary mission was determined as the maintenance of fixed exchange rates, given that all currencies were pegged to the U.S. Dollar, which in turn was dependent on the price of gold. If a country experienced short-term balance-of- payments difficulties, the Fund would intervene and provide them with financial relief as fast as possible. In the 1970s, however, the principle of the Bretton Woods System got replaced by floating exchange rates whereas the IMF contin- ued to exist and gradually increased its global impact. ³

2.1.3 Governance Structure

As the economic environment is in a constant state of change, the governance structure has to evolve in line with the ongoing process of globalization. Nowa- days, their influential power is distributed among various entities of the IMF con- struct of which the Board of Governors represents the highest decision-making body. The Board is composed of one governor - who is typically the head of the Central Bank or the minister of finance – and of one alternate governor for each member country as well. They are provided with advice by two committees, called the International Monetary and Financial Committee as well as the Devel- opment Committee. Even though both of them are formally not entitled to make decisions, they exert a significant influence on the Board concerning the strategic direction on future policies and projects.⁴ Another further important unit is the Executive Board, responsible for the supervision of the day-to-day business. Each of the 24 directors looks after either one large economy, for instance the US, Germany and China, or manages several countries, divided into constituencies.⁵ In 2011, Christine Lagarde was appointed Managing Director and is therefore both, chairwoman of the Executive Board and Head of Staff. ¹ A First Deputy Manag- ing Director and three more Deputy Managing Directors serve her as assistance. ²

2.1.4 Distribution of quotas and votes

Every country that wants to join the IMF is obligated to pay an arbitrary amount of money, called its “quota“³, which are denominated in Special Drawing Rights (SDR) ⁴. A minimum of 25% of this sum has to be paid in international reserve currencies, which means US-dollar, euro, pound sterling or yen. In March 2011, the quota formula has been reformed. Now, it is determined as the average of dif- ferent factors with individual importance: Gross Domestic Product (GDP) has a weight of 50%, general openness of the country counts 30%, economic variability influences the value by 15% and international reserves by 5%.⁵ In addition, a quo- ta mostly determines the member’s voting power. Every member state owns about 750 basic votes and obtains one extra vote for each SDR 100,000 of quota. Cur- rently, there is a total of circa SDR 238,182,700 in possession of the IMF. With their deposit of 42,122.400 of SDRs, which equals $59 billion, the United States are the largest member controlling 16.74% of votes.⁶ Tuvalu, a Pacific Island Na- tion⁷, owns the least voting power with only 0.03% and a quota of SDR 1.8 million, which equals $2.5 million.⁸ In the same reform of 2011 already men- tioned above, it was agreed that every five years, the distribution of quotas and votes will be adjusted. Nevertheless, the fact that some industrialized member states have a demanding voice due to greater financial resources leads to contro- versial discussions. This issue will be again dealt with in section 5, under “Criti- cism”.

2.2 Areas of responsibility

2.2.1. Lending

Although the IMF offers diverse services besides granting credits, its key function remains being the “lender of last resort“¹ for all countries facing either potential or urgent balance of payments deficits. In the course of time, the IMF has launched a vast number of aid-programs addressing different target groups.

On the one hand, there are non-concessional loans, as for example the Stand-By Arrangement (SBA) representing the oldest type of non-concessional financial assistance of the IMF. This arrangement lasts 12 to 24 months and afterwards, the refund, sum plus interest rate, is due within three to five years. However, many governments repeatedly applied for the SBA. For this reason, the IMF introduced the Extended Fund Facility (EFF), including fundamental economic reforms that help to overcome serious financial difficulties within a timespan of up to four years. In this case, the repayment must take place within four to ten years. There are further programs, called the Flexible Credit Line and the Precautionary and Liquidity Line.²

On the other hand, the Fund made every effort to design aid-packages for different variations of economic problems occurring over the years and as a consequence, it offers three programs of concessional lending, tailored to the special circumstanc- es of Low Income Countries (LIC) in our dynamic, globalized environment today. Interest rates varying between zero and one percent, longer periods of amortiza- tion - subsidized by the developed nations, these programs feature fair repayment modalities.³ Poor countries suffering from growth- and balance of payments prob- lems in the medium to long run can benefit from the Extended Credit Facility. It is intended to guide the country “towards a stable and sustainable macroeconomic position”⁴ with a duration of five years and a maximum time of ten years to pay back the money. The second program for short-term financial needs is called the “Standby Credit Facility” and represents the equivalent to the SBA, but with a lower interest rate of merely 0,25%.¹ In the beginning of this year, the Rapid Credit Facility was an essential help when the Ebola epidemic burst out: Approx- imately $404 million in total were transferred to the governments of Guinea, Libe- ria and Sierra Leone.² This program ensures a fast and flexible supply of means in case of natural disasters, shocks and emergencies.

Lending money, however, is not the only adopted measure to solve financial prob- lems. By implementing macroeconomic policies, individually adjusted to the country’s needs, the IMF wants to guarantee a long lasting improvement of the situation. Additionally, these conditions are meant to enable a fast repayment of the borrowed sum, so that other countries being in trouble can also be provided with sufficient resources.³ The Fund does not command a government to apply certain policies, but the member country itself describes possible policy changes they are willing to undertake in a “Letter of Intent“ in order to receive a credit.⁴ These austerity measures often include several of the following actions⁵:

- budget cutbacks of government expenditure with the help of fiscal-, credit- and monetary policies. This can lead to higher taxes, decreased social security benefits, less money for the health- or educational sector, etc.
- salary reductions in specific sectors or a decrease of the minimum wage, re- spectively
- the increase in interest rates to stabilize the currency and to stop inflation
- the privatization of public institutions and publicly held companies
- job cuts, especially in the public service
- the creation of incentives for external investors and firms by reducing trade restrictions
- the removal of certain subsidies

Countries can request a credit in the amount of a multiple of their quota. Depend- ing on the type of the aid-program and on other general circumstances, the amount of the credit can be expanded.¹ Greece, for instance, broke the record lending 3,212% of its quota as part of the first bailout in 2010.² However, to be granted a bailout fund, certain criteria must be fulfilled.³

Without having a realistic overview of a country’s economy, the IMF can neither evaluate if financial support is really needed nor which aid-package would be the most appropriate. Therefore and for several other reasons, monitoring its 188 members plays a central role and it is one of the most important tasks of the IMF.

2.2.2 Economic surveillance

Defined in article IV of the IMF’s Articles of Agreement, the Fund has the right to get a detailed insight into a member’s fiscal and monetary system since the ob- tained information provide a basis for all of their aid performances. There are two ways to receive the desired overview of a country, called bilateral- and multilat- eral surveillance. The former implies a meeting, usually held once a year, partici- pating IMF staff and relevant stakeholders of a member country. They use this opportunity to identify risks and vulnerabilities by having discussions with the government, central bank, private investors, members of parliament and civil so- ciety organizations. Afterwards, the Executive Board will be informed about the results in order to develop policy advice.⁴ Especially for LICs “where alternative information sources tend to be limited and local capacity often constrained” ⁵, bi- lateral surveillance is helpful. However, it is insufficient regarding a country’s economy in an isolated position, as all continents are deeply interdependent. For this reason, multilateral surveillance aims to discover potential risks at a regional or global level to avoid a “spillover” – the effect that one country can be signifi- cantly influenced by a primary effect in another country, even though both might be geographically separated.¹ The importance of revealing spillovers as soon as possible became clear in 2007/2008, when the global financial crisis came to Eu- rope, although it has had its beginnings in the American housing market. Since 2011, the IMF publishes spillover reports, since 2012 External Sector Reports and there are plenty of other releases including analyses and advices - The World Economic Outlook and Regional Economic Outlook are just two examples of many that prove the increasing transparency.²

2.2.3 Capacity development

The third area of responsibility is called “capacity development” which consists of various trainings and technical assistance, the IMF performs to share its expertise with the world.³ They were invented to respond to “evolving global macroeco- nomic developments and policy challenges, membership demands, and technolog- ical innovations“. During 2015, 345 training events took place and among all par- ticipants, there were over 11,300 officials coming from different member states. Also, half of both trainings and technical assistance were mostly attended by emerging market, mostly Africa.⁴ To enable an easy accessible participation, the IMF has enhanced its training offer through so-called massive open online courses which are for free and for everyone who is interested - whether students or gov- ernments. These are interactive lessons, containing short video segments, quizzes and hands-on exercises. ⁵

[...]

¹ Kell, M. and Williams, C. (2015), p.46

¹ UN (n.d.) [URL]

² IMF (n.d.) [URL], see “Fast facts“

³ IMF (2015a) [URL]

⁴ IMF (2015b) [URL]

⁵ BWC (2012) [URL]

⁶ Wolff, E. (2014), p.13

¹ DOS (n.d.) [URL]

² DOS (n.d.) [URL]

³ Setton, D. et. Al. (2008), p.9

⁴ IMF (2015c) [URL]

⁵ IMF (n.d.) [URL]

¹ IMF (2013a) [URL]

² IMF (2011) [URL]

³ IMF (2015d) [URL]

⁴ SDR is the unit of account of the IMF. It is used as international reserve with a daily fluctuating value. Until World War II, its value was based on the price of 0.888671 grams of gold. Since the Bretton-Woods System has been abolished, the SDR embodies a mixture of the euro, Japanese yen, pound sterling, and U.S. dollar. On November 10th, 2015, 1 SDR = $1.3797

⁵ Cf. IMF (2015d) [URL]

⁶ Cf. Ibid.

⁷ AA (2014) [URL]

⁸ IMF (2015e) [URL]

¹ IMF (1999) [URL]

² IMF (2015f) [URL]

³ IMF (2015g) [URL]

⁴ Cf. IMF (2015f) [URL]

¹ IMF (2015f) [URL]

² IMF (2015), p.12

³ Cf. IMF (2015f) [URL]

⁴ IMF (2015h) [URL]

⁵ Setton, D. et.al. (2008), p. 13

¹ IMF (2015d) [URL]

² IMF (2013b), p. 9

³ Every aid-package requires different characteristics a country must have to be qualified for it. Furthermore, the IMF evaluates its creditworthiness with the help of the Policy and Institutional Assessment (CPIA-Index). Analyses get conducted about the level of indebtedness, exogenous shocks, about the quality of the country’s institutions and the quality of national economic poli- cies.

⁴ IMF (2015i) [URL]

⁵ Lombardi, D. (2005), p. 20

¹ Cf. IMF (2015i), [URL]

² IMF (2015i) [URL]

³ IMF (2015j), p. 53

⁴ Cf. Ibid, p. 60

⁵ Cf. Ibid, p. 18f.