THE DEMANDS OF A CHANGING WORLD ECONOMY AND THE IMF

The world economy has undergone a sea change in these 60 years since IMF was founded, and the IMF's membership has expanded to 184 countries. The IMF's role and work have evolved in response, but, like any large organization, its ability to change has been limited by its own rules and mandate and has been held back by inertia. That inevitably leads to some mismatches between the reality and the ideal.

Cumulative change

For the first two decades after Bretton Woods, the world economy did change gradually, but the cumulative effect was dramatic. The first major change to affect the IMF was the growth in economic and financial strength of countries outside North America. At the end of World War II, the United States accounted for 22 percent of world exports and held 54 percent of official international reserve assets. Those percentages were reflected in a 33 percent quota share for the United States in the IMF, and it was broadly accepted that the Fund would not make any major decisions without U.S. approval.

Western Europe restored currency convertibility in the 1950s, replaced bilateral trade arrangements with open multilateral trade, and achieved strong economic growth. The Federal Republic of Germany, which joined the IMF in 1952, enjoyed a particularly rapid ascent. Following the formation of the Common Market in 1957, a series of increasingly tight monetary arrangements enabled a European currency zone to emerge. Europe thus strengthened its position in the world economy and maintained its position in the Fund hierarchy.

The development of Asia began with Japan, which also joined the IMF in 1952. Many elements of Japan's success were later emulated by other rapidly developing economies in East Asia, including various economic regions of China, the Republic of Korea, Malaysia, and Thailand. Although Japan eventually (in 1992) obtained the second-highest quota in the Fund, and China's quota was raised sharply after the People's Republic assumed the China seat in 1980, Asian quotas generally lagged well behind the economic importance that these countries were reaching.

The Middle East gained economic importance with the rise in petroleum prices in the 1970s. Saudi Arabia, in particular, saw its IMF quota rise sharply and in the 1980s, it became the Fund's principal creditor.

In the IMF's original Articles of Agreement, Latin America was granted a special status that afforded it the right to elect 2 of the Fund's 12 Executive Directors separately from the other electing members. That provision was dropped in 1978.

The combination of these sweeping changes in relative economic importance and the tendency for most quota shares to be adjusted only marginally in the course of general quota reviews have resulted in a weak correspondence between quota shares (and voting power) and the size of a country's economy, international trade, and finance. While the U.S. share has declined by half in the past 60 years, that of Europe has changed but little, and Asia's has grown by less than most formulas would have suggested.

Another consequence of the narrow geographic locus of economic influence in the 1940s was an informal understanding that the United States would nominate the President of the World Bank and would leave the nomination of the IMF Managing Director to the other members. Because the other members were dominated by Europeans, a tradition developed that this group would pick one of its own to be the Managing Director. Again owing to inertia and the force of tradition, this situation has not evolved despite the rise in economic strength and influence of other regions.

More fundamentally, the rise of multiple centers of economic power has brought changes in the world economy. By the 1960s, the Bretton Woods system of fixed but adjustable exchange rates anchored on the U.S. dollar had become a high-maintenance operation. The system collapsed in the early 1970s. In the aftermath, the effort to restore stability to the exchange rate system was extended well beyond the G-10 to include the full membership of the IMF, in the form of the ministerial-level Committee of Twenty (the forerunner of today's International Monetary and Financial Committee).

Nonetheless, the outcome-a compromise in which the choice of exchange regime was left to each member country and the IMF was given a vague mandate to oversee the system- was negotiated separately by two of the original postwar powers, France and the United States.

Cold War divisions

The end of the Cold War affected the IMF in three ways.

* It led to a rapid increase in the number of members and to a near universality in membership.

* Servicing this increased membership required a large increase in the size and diversity of the staff: not just passport diversity, but diversity in backgrounds and expertise to cope with the structural issues associated with integrating the new members into the world economy and fostering a transition toward market economies.

* The nature of the political interests that influence IMF lending decisions shifted from those based on East-West conflicts to those based more on regional or internal security issues or on economic alliances.

More low-income members

When the IMF was founded, most of the continent of Africa was under European colonial rule. Only Egypt, Ethiopia, and South Africa were among the 40 original members of the Fund. Most other African countries gained independence and joined the IMF between the late 1950s and the early 1970s, and the rest joined by 1990.

Operationally, the first main effect of the rise in African membership was to generate a large group of potential borrowers. To accommodate their needs, the IMF established a temporary Trust Fund in 1974 to lend on concessional terms for the first time. Repayments of Trust Fund loans eventually financed the Structural Adjustment Facility (SAF) starting in 1986. The Enhanced SAF, introduced in 1987, and its 1999 successor, the Poverty Reduction and Growth Facility (PRGF), enabled the IMF to continue offering longer-term concessional loans to low-income countries through these administered accounts.

A second and closely related effect was to immerse the IMF more deeply in issues of structural reform. The primary need of most African countries was sustained financing for development, which in turn required these countries to demonstrate a sufficient commitment to economic and governmental reform, stable implementation of sound macroeconomic policies, and economic openness to be able to attract donor support. The IMF had neither the resources nor the mandate to provide sustained financing, but it could and did try to adapt its financing and its policy advice to support the necessary strengthening and reform of economic policies. The scope of program design and policy conditionality expanded greatly in the 1990s, but the benefits were limited. In 2002, the IMF adopted tighter guidelines to streamline and better focus its structural policy conditions.

Globalization of financial markets

The growth and globalization of private financial markets have also had major effects on the IMF. At the close of World War II, the role of private international financial flows was very limited. Cross-border portfolio flows were circumscribed by national controls and currency regulations, with the effect that currency speculation was, for the most part, restricted to leads and lags in settling trade credits. This combination of limited activity and general distrust had important effects on the design of the IMF, but those effects have largely been overtaken by events. Consequently, actual practice has differed from the original plan.

First, Article VI of the Articles of Agreement was drafted to prohibit the Fund from lending to a country "to meet a large or sustained outflow of capital." Once private capital markets began to grow and spill across borders, however, the distinction between IMF lending for current and capital account transactions became meaningless. The expansion of IMF lending to mitigate capital account crises in the 1990s was both inevitable and inherently controversial.

Second, the IMF was empowered by Article VI to compel a country suffering a capital outflow to impose capital controls as a condition for borrowing from it. Since countries came to view either devaluing or borrowing from the Fund as preferable to imposing capital controls as a means of stemming a capital outflow, the IMF has never invoked this provision.

Third, the IMF's jurisdiction over exchange controls and its responsibility for overseeing their dismantling were restricted to controls related to payments on the current account. Countries would be in compliance with the provisions of Article VIII once they had eliminated controls over currency exchange for current account payments and had agreed not to reimpose such controls, irrespective of any controls on capital flows.

The increase in the breadth and depth of international private capital markets has also altered relationships between the IMF and its member countries by creating a class of members that have no likely prospect of ever drawing on Fund resources. The IMF was designed as a rotating fund on which any member might draw in time of need. Starting in the early 1960s, however, the more advanced economies developed various financing alternatives, starting with swap agreements among central banks but later relying primarily on borrowing in private markets. The combination of access to private international credit markets enjoyed by the advanced economies since the 1970s and their reliance on flexible exchange rates to absorb the strain of payments imbalances has eliminated their need for IMF financing.

What next?

On this 60th anniversary, the core principles and mandate of the IMF remain intact, but the need for constant adaptation to an evolving world economy is undiminished. Four key issues stand out as calling for attention in the years ahead.

First, the IMF's surveillance over its members' economic and financial policies must be strengthened so that the institution can provide more effective early warnings when economic trouble looms.

Second, the IMF needs to ensure more effectively that its lending to help resolve financial crises restores countries' access to capital markets and supports a revival of economic growth.

Third, the IMF must do more to ensure that its policy advice and financial support for low-income countries are appropriately directed toward helping those countries emerge from poverty.

Finally, reform of the IMF must address the equity and effectiveness of the way the institution is governed.