Chapter 10 Review Questions Answer Key

The International Financial Institutions

The International Monetary Fund was set up to oversee the workings of the Bretton Woods system. Each member country paid into the IMF a quota of its own currency, as well as some gold or dollar holdings based on the size of its economy. When facing economic problems, countries would be permitted to draw temporarily on the reserves of the IMF to pay off international debts. Usage of these funds was intended to provide a country with sufficient time to stabilize its economy without resorting to measures such as currency devaluation that could destabilize the system. Notably, at this point, the IMF functioned as an important yet modest instrument to maintain international currency stability. This initial role gave no hint of the fund’s later emergence as a powerful agent within international development. Along with the establishment of the IMF came the creation of the International Bank for Reconstruction and Development (IBRD), which later became known as the World Bank. The original role of the IBRD was to make loans at preferential rates of interest to European countries devastated by war. This function greatly diminished when the US’s own Marshall Plan began to provide credit directly to European nations in 1947. Fortunately for the fledgling IBRD, a new and growing set of clients emerged through the ongoing process of decolonization. By serving as a bank to provide development finance directly to these new countries, the IBRD found a key role. [pp. 169-70]

The countries of South Korea, Taiwan, Hong Kong, and Singapore did not follow the structural adjustment model. While they embraced export-oriented growth, they achieved it through sustained involvement of the state in protecting and subsidizing selected industrial sectors to compete on international markets. The successes of the East Asian countries were encapsulated in the notion of an “East Asian miracle,” which seemed to contrast greatly with the experiences of countries in Latin America and Africa that had followed the orthodox structural adjustment model. [p. 175]

As the decade of the 1970s drew to a close, a period of economic turbulence created new problems for many developing-world countries that were faced with the dual burden of high oil prices and falling income from their key exports. To overcome budget deficits, many borrowed heavily from private international banks that were keen to make lucrative high-interest loans to the developing world. When, in 1982, the US made a unilateral decision to raise interest rates, numerous countries across Latin America and Africa faced daunting levels of debt. Mexico was the first to threaten default and by October 1983, some 30 countries owing a total of $239 billion had or were attempting to reschedule debt payments. Given the magnitude of the loans facing default, a number of major US and international banks feared collapse, and this raised the spectre of a financial crash engulfing the entire Western financial system. In response, the IMF and World Bank began to pipeline billions of dollars to debt-stricken countries as a means for them to continue making payments on their old debt. In becoming the funnel for emergency loans to the South, the IMF and World Bank proposed dramatic reforms for developing countries to implement. To overcome the debt crisis, they argued, it was not enough merely to stabilize the economies of the developing world through standard austerity programs. Rather, a more profound process of transformation was necessary alongside austerity: one that would open countries to foreign trade and reorient them toward export production. To achieve these objectives, borrowing governments were mandated to rapidly cut back trade restrictions, end support to domestic industries, and remove subsidies to key consumer goods. The idea behind such liberalization was that market forces could then play a greater role in distributing resources across the economy, leading to improved efficiency and wealth creation. At the same time, foreign investment would flow into export-oriented sectors of the economy to create new economic dynamism and earn the country valuable foreign earnings. This project became known as “structural adjustment.” [p. 174]

Consequently, in the early 2000s, the bank introduced what it called a “comprehensive agenda” for development that encompassed not just economic policies but also the institutional, human, and physical dimensions of development strategy. These areas range from good governance and the rule of law through to social safety nets, education, health, rural and urban strategies, and environmental and cultural dimensions. Together, they form an ambitious policy agenda covering a holistic range of issues that broadens the scope of policy and institutional reform well beyond the original confines of structural adjustment. Critics, however, suggest that this expansion has drawn the World Bank into policy areas that far exceed its expertise. Others suggest that solidifying structural adjustment in this manner is unlikely to have a profound developmental effect. Instead, they advocate a move away from the market-centric model to one that acknowledges the central importance of the role played by the state in development. [p. 177]

Despite the origins of the 2008 financial crisis in the West, a number of factors conspired to hurt developing economies, including the collapse of important commodity prices, diminishing demand for exports, declining investment flows, the reneging on aid promises by Western countries, and a considerable drop in remittances from migrant workers based abroad. Moreover, unlike Western countries that used large-scale deficit financing to attempt to prop up consumption and alleviate unemployment, many Southern countries do not possess such means. They faced profound economic contraction with unsettling implications for wages and employment, as well as growing pressures on financing for social programs and other public-sector expenditures. These factors, moreover, acted in combination with the elevated prices of food commodities. Indeed, the food crisis alone was judged to have thrust a further 100 million people into poverty during 2008. [p. 181]

It refers to a view of poverty that is marked by not just a lack of income but also is manifested in the conditions of “voicelessness” and “vulnerability.” Indeed, poor people suffer from an inability to influence political processes (voicelessness) and, because of a lack of assets, are unable to adapt to sudden shocks, such as the illness or unemployment of a primary wage earner (vulnerability). The Bank saw these dimensions of poverty interacting and reinforcing each other. [p. 179]

With the relative economic power ongoing with the growth of China, India, and other key developing countries, changes were proposed to the voting rights and seats on the boards of governors for both institutions. The voting systems were heavily weighted in favour of the Western countries. The proposed change could give a higher voice to the developing countries. Negotiations are still ongoing to give greater presence to developing countries in terms of voting rights and seats on the board of the IMF. This process, however, is fraught with conflict because various European countries—which stand to be the prime losers in the process—have blocked numerous proposals for change. [pp. 182]

In the late 1980s and early 1990s, Mexico was heralded as a success story that many advocates of structural adjustment used to justify its validity. The structural adjustment program pursued by Mexico in the 1980s had initially imposed considerable economic and social dislocation. However, with inflation tamed and market liberalization encouraging a stream of US investment into export-oriented industries in the early 1990s, Mexico appeared to be booming. Proponents suggested that rapid economic growth would remedy low wages and high poverty levels. In late 1994, however, the flows of investment turned into capital flight as investors became afraid that the Mexican boom was built on unstable foundations. Mexico was thrown into a deep recession, with wages falling further and unemployment increasing. The economic turmoil was resolved only when the US sponsored a massive bailout package and the Mexican government took over the debts of private banks. [pp. 175-6]

Owing to high levels of debt during the 1980s, the IMF and World Bank wielded considerable influence over many countries in sub-Saharan Africa. As a result, these countries often undertook profound structural adjustment programs. The results, however, were greatly disappointing. With only a few exceptions, the region was characterized by moribund economies and worsening social indicators during much of the 1980s and 1990s. Critics also claimed that the increase in armed conflict in the region and the escalating HIV/AIDS crisis were strongly related to the destructive impact of structural adjustment upon state capacity. [p. 175]

To explain the poor record of structural adjustment, the bank introduced the concept of “good governance.” Insisting that structural adjustment remained the only correct long-term solution to the problems of developing-world countries, the bank argued that positive outcomes were often lost because poorly run state institutions were not enabling markets to work efficiently. In short, market liberalization was not failing the developing world but, rather, “bad governance” was failing the markets. In response, the World Bank has strongly promoted the goal of “good governance” as a remedy to development problems. The aim of good governance is to craft a political architecture that supports market economies through transparency, rule of law, and accountable decision-making. In the World Bank’s view, corrupt government officials often make decisions favouring specific interests in return for monetary reward, and this skews the playing field and reduces the efficiency of the market. For good governance to prevail, the bank argued, it was necessary to find mechanisms that would enforce transparency and accountability. The former would ensure that citizens could see how decisions were made and therefore could compel state officials to make decisions that benefitted the common good, not special interests. Simultaneously, if the rule of law is not applied freely and fairly, the legal basis for a market system can falter. As Adam Smith argued some 200 years earlier, market actors must be certain that their private property is secure, and their contracts will be upheld. If the law is not applied equally, a lack of confidence in the rules of the game will restrain market activity and frustrate development. As a consequence, good governance also must include judicial independence from both governmental influence and private actors and requires an accountable police force to implement the rule of law with an even hand. [p. 176]

In response to the Asian crisis, the IMF claimed the problems were homegrown and placed the blame on “crony capitalism.” According to the IMF, the close relationships between East Asian governments and local businesses had made it impossible for foreign investors to judge the true conditions of the markets. This contributed to an overestimation of the strength of East Asian markets, leading to overinvestment and eventually financial panic once true market conditions were revealed. Good governance—i.e., openness, accountability, and transparency within East Asian governments—was prescribed as the solution, along with a series of new international institutions known collectively as the “new international financial architecture.” These institutions were intended to promote financial transparency and coordinate actions among key nations at an international level. Critics, however, lambasted the IMF’s position. They pointed out that the fund had praised the East Asian countries just prior to the crash of 1997. The IMF, they claimed, had been cavalier in its approach to capital account liberalization, ignoring the potential risks by encouraging countries to liberalize rapidly without effective regulatory structures. This created the risk of rapid financial meltdown in countries with otherwise sound economies. Moreover, the immediate response of the IMF to the crisis was to make bailout loans conditional on reform measures similar to structural adjustment programs. The former World Bank chief economist Joseph Stiglitz was among those who argued that this IMF intervention was entirely inappropriate for the East Asian countries and greatly exacerbated the severity of the crisis. Besides denting the image of the IMF, another consequence of the Asian debacle has been the buildup of large foreign reserve stockpiles by East Asian countries in order to avoid having to turn to the IMF in the future. [p. 178]