Klaus Liebscher: The importance of the Bretton Woods institutions for small
countries
Opening address by Dr Klaus Liebscher, Governor of the Austrian National Bank, at the Conference
on "60 Years of Bretton Woods - governance of the international financial system - looking ahead",
Vienna, 21 June 2004.
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Ladies and Gentlemen,
It is with great pleasure that I may welcome you to the conference on "60 Years of Bretton Woods -
Governance of the International Financial System - Looking Ahead" hosted by the Oesterreichische
Nationalbank. I am equally delighted that we managed to attract so many distinguished speakers from
around the globe, who are here in Vienna today to discuss various aspects of the governance of the
international financial system with us. I would like to express my sincerest gratitude to all these
speakers for their contributions in advance. I feel also honored that such a great number of you have
accepted our invitation to participate in what promises to be an ideal opportunity to reflect upon the
history and future of the Bretton Woods Institutions.
During our conference it is supposed that policymakers, investment bankers and academics will
discuss the governance of the international financial system, debate about exchange rate issues and
explore ways to improve the current crisis prevention and resolution framework. We believe that these
three broad themes are central to the debate on the international financial architecture.
1. A brief review of 60 years of Bretton Woods
The 1930s demonstrated that the pursuit of nationalistic beggar-thy-neighbor policies can have
dramatic and devastating effects.
In order to prevent a repetition of this destructive experience, the Bretton Woods system consisting of
the International Monetary Fund (IMF) and the World Bank was created in 1944 to govern the post
World War II economic system. This regime was expected to perform three important functions:
•
a regulatory function by administering the rules governing currency values and convertibility,
•
a financial function via the supply of supplementary liquidity to members facing balance of
payment pressures and
•
a consultative function by providing a forum for cooperation among governments.
I consider the Bretton Woods system very innovative for four reasons: First, with this system
international monetary cooperation was for the first time attempted on a permanent and institutional
basis. Second, this system respects the principle of national sovereignty while committing members to
collective responsibility. Third, it provides a mechanism for inter-governmental consultation. And
fourth, even though the principle of national sovereignty is respected, voting rights are allocated in
proportion to quotas rather than on a one-state, one-vote basis.
The first major systemic crisis - the breakdown of both the gold exchange standard and the par value
system of the original Bretton Woods system in the early 1970s - was weathered surprisingly well.
Unlike during the 1930s, monetary relations did not degenerate into total chaos. Instead, a significant
degree of cooperation was preserved under the auspices of the IMF.
Later on the international financial system has been exposed to a string of crises since the early
1980s. But the IMF in particular was chastised for its role in the crises of the mid- and late 1990s. A
common feature of these crises was that they grew out of weaknesses in domestic economic policy
frameworks accentuated by international capital flows and often in combination with unsustainable
fixed exchange rate pegs. In most of these cases, Fund surveillance had not ex ante and publicly
stressed the weakness of domestic or financial sector frameworks or questioned the inconsistence of
economic policies with a fixed peg.
The social impact of crises on countries raised questions about the IMF's approach, its quality of
advice and accountability. Academics, policymakers and nongovernmental organizations alike
criticized the IMF for advocating rapid capital account liberalization and paying insufficient attention to
the foundations for stability and growth; for applying a 'one-size-fits-all' model that was insensitive to
countries' individual circumstances and needs; for advocating policies that served primarily the
interests of creditors and for being insufficiently open to outside views and advice.
While some of this criticism seems justified, I do not wish to ponder the counterfactual: what if the IMF
had not existed and thus would not have helped resolve these crises? In addition, the Independent
Evaluation Office of the IMF, having reviewed some of the aforementioned criticism, refuted most of it.
In other areas, the Fund reacted to the criticism and has changed some of its policies, for instance
with respect to capital account liberalization. To my mind, these are very important developments
which show that the Bretton Woods Institutions are -without any doubt - learning institutions. What is
more, these institutions are of significant importance when we look for an orderly solution to economic
imbalances or financial crises.
2. Multilateralism and governance of the international financial system
The main function of international financial institutions today is to provide the best framework for the
governance of globalization so that this process becomes a win-win proposition, in which all
economies ultimately benefit through productivity and growth effects.
This means that a level playing field should exist that governs the integration of national economies via
trade in goods and services in particular to minimize unfair cross-border competition. A world of global
capital markets offers faster rewards for success both for the countries concerned and for the
international system; on the other hand, weaknesses are also punished harder and faster than before.
Globalization presents all economies with new opportunities.
More substantial trade and investment flows lead to lower prices and greater choice, larger markets
and economies of scale and faster adoption of new technologies. Stiffer competition among firms and
exposure to the world's best-practice standards as well as free movement of capital generate a more
efficient allocation of resources. Thus, globalization can play a major role in enhancing growth and
living standards.
However, there are risks associated with globalization and liberalisation that need to be properly
managed by policymakers. Globalization entails not only new opportunities but possibly also new
inequalities that need to be anticipated and addressed both in developed and developing countries. As
a case in point, the recent financial instability demonstrates the risks associated with volatile global
capital markets. Fully opening up to liberalisation too early and too quickly, without the necessary
preparations, is dangerous. Countries must first put in place appropriate policies and institutional
frameworks. The IMF's surveillance mandate is just the instrument to achieve this aim.
3. Surveillance and crisis prevention
Self-surveillance is the most effective form of surveillance since self-interest should motivate countries
to pursue stronger policies. The ultimate reward for countries with improved policies will be higher
economic growth, and a higher standard of living for their citizens.
The effectiveness of external surveillance - like the IMF's surveillance mandate - is very much
dependent on the credibility of the review process. International organizations can add weight to local
voices: national think tanks or academics might have said something many times over and, yet, it
helps to have a credible body such as the IMF says it, too.
Therefore, international organizations must ensure that the analysis and advice presented to countries
is not perceived either to be tainted by special interests or weakened by the use of flawed analytical
methods.
As to its surveillance mandate, the IMF faces critical limitations. In seeking to provide good advice, the
IMF is constrained for example by a country's economic progress and authorities' willingness to follow
up on advice. However, based on experience across many countries, a consensus has emerged about
the broad guidelines for policies that serve the goal of sustained growth and thus should help in
preventing crisis. These policies include, among other factors, the need to support an appropriate
macroeconomic and microeconomic environment, the need for a market-oriented system with a high
level of competition, openness to international trade and investment, price stability and exchange rates
that broadly reflect international competitiveness.
All of this has led to a shift in the crisis prevention strategy employed by the IMF. The IMF now
concentrates on identifying vulnerabilities, such as excessive sovereign debt or balance sheet
mismatches. Also, its stance on capital account liberalization has changed. Today, the IMF advocates
that member countries should first have the institutional capacity and a relatively strong financial
sector with a sound supervision regime before taking this major step. In fact, before fully liberalizing all
capital movements in 1991, Austria had followed this policy. Back then, Austria was criticized for this
policy which has now become conventional IMF wisdom.
One important initiative in the sphere of crisis prevention is the Financial Sector Assessment Programs
(FSAP), which are conducted together with the World Bank. An FSAP is designed to establish a profile
of the strengths and weaknesses of the financial sector of a given country. This initiative is not only
geared towards emerging market countries (EMCs) or developing countries, but also towards
industrial countries. Austria, for example, just conducted an FSAP with excellent results.
Another important area constitutes economic and financial standards and codes, which are formulated
in collaboration with public and private sector institutions. Their aim is to promote meaningful
comparable statistics, transparency rules for fiscal and monetary policies and supervisory standards
for the banking, securities and insurance sectors. This is meant to facilitate the integration of countries
into the global economy.
Will all of these initiatives prevent financial crises altogether? Overshooting and correction will always
be part of financial markets. This means that in an open and dynamic market economy there are limits
to our capacity to anticipate and prevent crises.
However, with skillful and prudent economic, monetary and financial policies, crises should occur less
often and they should be less severe.
4. Crisis management and resolution
Over the last 20 years, the Bretton Woods Institutions had to deal with a continuous series of financial
incidents. These crises encompassed economic misalignments and systemic vulnerabilities, such as
evinced in the Mexican or East Asian financial crises and financial disruptions due to contagion across
countries and markets, as for example during the Russian debt default of 1998.
The success of the Bretton Woods Institutions should be reflected in a declining trend of the overall
number of Fund-supported programs over time. There are legitimate cases which require access to
Fund resources. However, the Fund's financing role should and can only be catalytic, given its limited
resources. While policies, such as the exceptional access framework, are in place to safeguard Fund
resources, they are often not adhered to.
I am also concerned about the prolonged use of Fund resources which is out of line with its mandate.
Countries that run IMF-supported programs over many years or decades are probably not a
demonstration of success. Thus, the IMF should strive to prevent that countries become dependent on
IMF financing.
During the debt crises of the early 1980s, the IMF acted more as a crisis manager or the official agent
in charge of concerted bank lending. This role has shifted over the years, with the Fund now practically
resolving countries' financial crises on its own. An important initiative to reposition the Fund once
again as a crisis manager came to be known as the private sector involvement (PSI) initiative. PSI
encapsulates the official sector's attempt to engage the private sector in crisis resolution more
effectively. The private sector has to assume responsibility for its investment decisions. This is
grounded in my firm conviction that a collectivization of private sector losses would distort the
allocative efficiency of capital markets and would lead to moral hazard via increased risk-taking.
Another important initiative, which the IMF started to discuss in late 2001, proposed to establish an
international bankruptcy procedure for unsustainable sovereign debt (SDRM). I believe that this
mechanism would have made the PSI initiative more operational. However, the time may not have
been ripe yet for such a comprehensive framework for the restructuring of sovereign debt.
Nevertheless, public and academic awareness has been raised.
The debate has helped in that many EMCs have introduced collective action clauses (CACs) in their
sovereign bond contracts and major EMCs and the private sector are discussing a Code of Conduct.
This notwithstanding, I am firmly convinced that we need an international arrangement which would
facilitate the orderly resolution of sovereign debt crises.
Such an arrangement would also help shift the function of the IMF from its current role as crisis solver
to crisis manager.
5. Economies in transition, developing countries and poverty reduction
In addition to finding more effective mechanisms for crisis prevention and management, the
international community faces another major challenge, the eradication of poverty.
One of our prerogatives should be to integrate developing and transition economies in such a way that
they can maximize the benefits of globalization, while minimizing the costs.
This implies, specifically, helping these countries attract sufficient sustained private capital flows, while
strengthening measures for crisis prevention and better crisis management, supporting policies and
structural reforms that facilitate development, and helping secure sufficient external funding to sustain
their growth and poverty reduction.
While not being a "development" institution in spirit and by design, the Fund's role in the developing
countries has nevertheless become an essential and integral part of the efforts of the whole
international community to advance development.
Especially by launching the HIPC (Highly Indebted Poor Countries), the PRSP (Poverty Reduction and
Strategy Papers) and the PRGF (Poverty Reduction and Growth Facility) initiatives, the Fund
substantially reframed its role in low-income countries, making poverty reduction and growth the key
objectives and modalities for programs supported by the Fund. While the PRGF relates strictly to the
Fund's role, the HIPC and the PRSP initiatives guide the cooperation with developing countries, the
Fund, and also the World Bank.
I see the Fund's role in developing countries and especially its financing role as catalytic rather than
substantial. The Fund should allocate only a limited amount of financial aid to developing countries in
support of their progress towards macroeconomic stability and financial soundness.
Turning to transition economies, I believe that we often overlook the strong track record both the IMF
and the World Bank have established in these countries.
While the Bretton Woods Institutions were caught as much by surprise by the collapse of Communism
as everybody else, their involvement in these countries was instrumental to their integration into the
world economy. At the beginning of the 1990s, the majority of transition economies had some form of
IMF involvement via a fully-fledged IMF program or technical assistance. The IMF together with the
World Bank worked hard to stabilize the economies of these countries, devise economic policies and
build modern institutions, thus transforming many of these economies into today's very successful
market economies.
Owing to a common history and its geographic location, Austria has a particular interest in the stability
and economic progress of the transition economies.
Austria had already started in the late 1980s to develop extensive economic ties with the transition
economies, which have increased substantially over time.
Strong trade linkages, very high levels of foreign direct investment and support for their integration into
either the EU or other international institutions have been mainstays of Austria 's policies towards the
transition economies. In addition, in 1992, Austria decided to participate in setting up the Joint Vienna
Institute together with the IMF and other international organizations to respond to the strong demand
from economies in transition to train officials in market economics and the free enterprise system.
6. Conclusion
Ladies and Gentlemen!
Austria joined the IMF and World Bank/IBRD in 1948 and has been an active and supportive member
of the Bretton Woods Institutions (BWI) ever since. Especially for a small open economy like Austria,
the BWI were and still are important windows to the rest of the world. Therefore, both the
Oesterreichische Nationalbank as well as the Ministry of Finance have always kept close and good
working relationships with the management and staff of the IFIs.
I am a firm believer in the value of the Bretton Woods Institutions for the global economy as a whole
as well as for small countries and the positive contribution they have made to the world economy. The
60 th anniversary, this conference or the strategic review of International Financial Institutions which is
presently conducted by the G 7 mark an opportunity to look afresh at these institutions, assess
whether they have fulfilled their respective mandates and reflect upon their future roles. However, I
expect that we will not attempt to overhaul the system which can be improved upon but ultimately has
worked to the benefit of all.
I sincerely hope and advocate that we go back to the roots of these institutions with the World Bank as
the primary institution for structural policies and development and the IMF as the institution for
shortterm macroeconomic surveillance, crisis prevention and crisis management rather than attempt to
redefine their respective roles. In addition, what sometimes is forgotten in many reform debates: these
institutions fulfill functions for all their members and cannot or should not be narrowed.
In concluding, I am looking forward to fruitful and challenging discussions during our conference and I
wish all of you an interesting stay here in Vienna.