IMF & Good Governance, The

A joint project of the Interhemispheric Resource Center
and the Institute for Policy Studies

In Focus: The IMF & Good Governance

Volume 5, Number 13
April 2000

Written by Carol Welch, Friends of the Earth
Editors: Tom Barry (IRC) and Martha Honey (IPS)

Key Points

The IMF was created to solve short-term, external imbalances in national economies but has moved far beyond its original mandate.
The IMF makes decisions with major implications for poor countries yet lacks the expertise to provide far-reaching policy prescriptions. Its structure also inadequately represents the poorest countries, which are its main clients.
While judging good governance—telling governments to make documents more accessible and to open up their decisionmaking processes—the IMF remains unaccountable and undemocratic.

Both the International Monetary Fund (IMF) and the World Bank were created in 1944. Originally the World Bank was charged with spearheading postwar reconstruction, and the IMF was created as the "guardian" of the global economy, promoting unimpeded trade and ensuring that countries' exchange rates were staying within their set values. (In the 1940s, the values of world currencies were pegged to gold—the "gold standard.") The IMF also provided short-term financing to countries that had difficulties defending their currencies' values and meeting trade obligations. But the fund's financing was intended to stabilize economies—not restructure them.

When the gold standard was suspended in 1971, the IMF lost its core mission. Since then, the institution has searched for a new mission and justification for its existence. As a result, the fund has consistently involved itself in affairs far beyond its original mandate. This has been done with grave consequences: the IMF, staffed with macroeconomists, does not have the expertise to provide the kind of advice that it is dispensing today. Nor is the fund (which has no independent evaluation unit and has been criticized for excessive secrecy) accountable for the policy advice that it gives.

The oil price shocks in the 1970s provided the IMF with a major opportunity to extend its mandate. The fund offered short-term loans to help some countries meet increased oil costs. It also encouraged international commercial banks to lend massive amounts of oil dollars to developing countries. This practice led to excessive and dubious credit, which then contributed to the debt crises of the 1980s.

The debt crises gave the IMF another role: lending to countries on the brink of default, making the IMF the lender of last resort and the global economic policeman, as it stepped in and set up a system of debt repayment to the Northern creditors. Since then, developing countries have needed the fund's "seal of approval" (IMF endorsement of an economy) to obtain new aid flows, further creating a dependency on the IMF by developing countries and granting the fund vast influence over these countries.

During the 1980s the IMF again extended the scope of its programs by moving into the development field, establishing its Structural Adjustment Facility (SAF) and Enhanced Structural Adjustment Facility (ESAF). Both these facilities have recently been merged into the IMF's new Poverty Reduction and Growth Facility (PRGF). Through the PRGF, the fund extends medium-term loans and sets strict economic conditions for broad sectors of a country's economy. These conditions—which can include relaxation of labor laws, foreign investment incentives in natural resource sectors, and privatization schemes—go far beyond the IMF's original purview of addressing short-term external imbalances.

Recently, the IMF has pursued an amendment to its Articles of Agreement that would give it jurisdiction over capital-account issues and potentially obligate IMF member countries to remove capital controls by which they protect themselves against volatile short-term capital. Another new endeavor is the IMF's involvement in "good governance," taking up issues such as corruption, budget transparency, tax policy reform, and corporate bankruptcy. Good governance is becoming an ever-important criteria both in determining multilateral and bilateral aid flows and in granting debt relief. As the institution that bestows the "seal of approval" and whose programs must be followed in order to obtain debt relief, the IMF has a strong hand in determining whether a country is meeting its standard of good governance.

Although the principle of good governance is broadly endorsed, bestowing the IMF with the power to determine good governance is problematic. It further legitimizes the fund's power grabs of the last several decades and entrenches its dubious role of giving advice where it is not an expert. Moreover, the IMF's own decisionmaking structures violate basic principles of good governance, such as representation and participation. The African continent is essentially represented by two individuals on the IMF board of executive directors, while the U.S. controls over 17% of the votes at the fund. Such an imbalance of political influence undermines the consistent application of good governance criteria. If the IMF is to advocate good governance principles to its member governments, it must apply the same principles of transparency and accountability to its own operations.

Problems With Current U.S. Policy

Key Problems

The U.S. has used the IMF, including the fund's policy on good governance, as a way of furthering narrowly conceived U.S. foreign policy interests.
The politicization of IMF lending decisions is created by its flawed voting structure, which is based on each member's contribution to the fund.
Good governance at the IMF is also thwarted by the fund's flawed practices of audit and evaluation.

In August 1997, the IMF released guidelines regarding its role in governance issues. According to then-Managing Director Michel Camdessus, "a much broader range of institutional reforms is needed if countries are to establish and maintain private sector confidence," and "every country that hopes to maintain market confidence must come to terms with the issues associated with good governance." The IMF announced plans to evaluate countries' governance practices and to condition its loans on good governance. The fund then flexed this new muscle when it withheld a loan to Kenya because of corruption concerns.

This new interest in good governance is ironic, given the fund's history. Kenya received IMF assistance throughout the early 1990s, and IMF lending may soon be resumed, despite protests from Kenyan civil society and political opposition leaders who claim that corruption continues. The fund loaned billions to Russia in the 1990s despite rampant evidence of corruption, as Russia's political and business elites reaped the spoils from IMF-mandated privatization schemes. The U.S. Treasury Department has strongly supported these IMF loans for its own political reasons.

The politicization of IMF lending decisions is created by its flawed voting structure, which is based on each member's contribution to the fund. As the largest financial contributor to the IMF, the U.S. has the largest share of votes—17%. Together the G-7 nations control nearly half the votes and thereby wield a heavy hand in setting the IMF's agenda. In addition, many of the IMF's most important decisions, such as amendments to its Articles of Agreement or use of the fund's gold reserves, require an 85% majority, thereby giving the U.S. veto power over the most critical decisions.

The U.S. has used its influence within the IMF as a way of promoting U.S. foreign policy through a multilateral fa�ade. The IMF's ever-expanding mandate—from macroeconomic stabilizer to development fund to good governance expert—has enabled the U.S. to exert its agenda in ever-increasing ways. In a break from the past, U.S. Treasury Secretary Lawrence Summers has recently acknowledged the IMF's expanding mission and has called for a "refocusing" of the fund's role. In practice, however, business seems to continue as usual, and debt relief for desperately poor countries is delayed by the mantra of preconditioned good governance reforms.

As an institution promoting good governance, the IMF itself is still too secretive. Many of its most important economic assessments of member country economies are confidential. Though loan documents are now generally available, they are released after board approval, when the public cannot influence decisions. The IMF's governing bodies are excessively secretive: the board of executive directors, the day-to-day decisionmaking body of the IMF, rarely takes recorded votes. Instead it negotiates a consensus behind the scenes and does not release its minutes.

Good governance at the IMF is also thwarted by the fund's flawed practices of audit and evaluation. The IMF has no independent evaluation unit or systematic appraisal process. Instead, it relies on ad hoc external reviews and on internal assessments. In addition, there is no mechanism that holds the IMF directly accountable for the quality of its advice and programs. For example, if a loan program is ill-designed or if consultation is flawed, civil society in a country has no mechanism to hold the IMF directly accountable for its mistakes. A credible accountability mechanism is central to any system of good governance.

Finally, IMF good governance criteria will never be credible as long as governance conditionality is imposed on member countries. Although the IMF has taken a very important step forward by agreeing to participate in national public forums with civil society, government officials, and other donors, the loan negotiation process is still too exclusive and secretive. According to Article V of its Articles of Agreement, the IMF negotiates directly only with the finance ministry and central bank of each member country. This article should be amended, and the IMF should work with a full range of government officials, including parliamentarians.

Toward a New Foreign Policy

Key Recommendations

The IMF should return to its original mandate of monitoring economies and lending for short-term stabilization; loan conditionality should be curtailed.
The U.S. must play a leadership role in reforming the IMF, such as making the fund's executive board more transparent and enhancing accountability through an independent evaluation unit.
The U.S. must give up its veto power at the IMF and work to increase the voting power and representation of poorer countries.

Given that the increasing dominance of private financial flows relative to official flows has shifted power and influence toward private sector capital, the role of the IMF has come into question in the last several years. This identity dilemma has been fomented by the continued stagnation of the poorest countries, despite many years of structural adjustment. Now, since the IMF will have a new managing director for the first time in thirteen years, is a propitious time to examine the fund's role in the global economy of the twenty-first century.

Reform of the IMF must be a key component of U.S. foreign policy priorities. The reform agenda includes downsizing the fund's role and determining exactly how it carries out its more restricted mission. The IMF was created to monitor economic developments in the global economy and to address short-term external imbalance when necessary. Treasury Secretary Summers' recent call for a refocused IMF is welcome, and this should be the starting point for a new U.S. policy. The IMF should return to it original mandate and lend to countries (rich or poor) facing short-term balance-of-payments problems. Conditions would be few, dealing strictly with core macroeconomic problems and with repayment to the IMF. Longer-term development lending for the poorest countries is better left to agencies with the appropriate mandate and staff expertise, such as the World Bank and certain UN agencies.

A surveillance function should remain part of the IMF's mission, with one important change needed to ensure improved global economic governance: the monitoring of private capital flows, which played a major role in the crises of 1998. But though the IMF should track these flows, imbalance created by such flows may not warrant IMF assistance, nor can the IMF realistically expect to match the volume of private capital. In today's world of massive, volatile capital flows, the IMF should not step in and bail out banks and private lenders who knowingly took risks investing overseas.

Good global governance means that speculators and bankers should not get special treatment. An independent, rules-based system that equally balances the importance of meeting human needs and public services with meeting obligations to creditors is necessary to ensure effective global governance. Because it is dominated by the finance ministries of the wealthy countries (particularly the U.S.), the IMF is incapable of achieving this important balance. With respect to the problem of mounting third world debt, the creation of an independent debt adjudication board (similar to U.S. bankruptcy courts) outside IMF control would be one way to establish such a rules-based system. The U.S. should give such an alternative proposal due consideration.

But while the IMF reins in its activities, it must itself adhere to principles of global economic governance, and the U.S. should take a strong role in ensuring that this happens. One step would entail freer access to information. The IMF's annual economic surveys—the Article IV consultations—should be public documents, although certain sensitive information could be withheld. Currently, the IMF only makes available—on a voluntary basis—a brief, sanitized summary. Drafts of loan documents should also be made public, so that civil society has an opportunity to voice concerns about IMF loan programs.

In addition, IMF governance would be improved by making the board of executive directors more democratic and more accountable for its decisions. The executive board's process of reaching decisions by consensus makes it very difficult for outsiders to verify the position of a particular country's representative. The current U.S. executive director admitted in an April 1998 congressional hearing that, in 2,000 decisions, she has only formally voted about twelve times. At a minimum, minutes of board meetings should be made available expeditiously, and board votes should be public. However, improved democracy and representation will not be achieved without a significant change in voting power within the board. For example, population size should factor into voting share, and no one country should have veto power at the IMF.

To enhance its credibility, the IMF should establish an independent evaluation unit that can systematically assess the effectiveness and impact of IMF policies and programs. This unit should be independent of IMF management and should consult with all interested parties to determine the full effect of IMF operations around the world. These reviews should be public, and the executive board should issue a response or action plan for each review's recommendations. The IMF should also establish a grievance office so that affected people have recourse to challenge a flawed IMF loan program in a country.

Finally, discussions between the IMF and a borrowing country must include the full range of government ministers and parliamentary leaders. Without the representation and agreement of a wide array of government authorities, IMF programs may not identify core problems, predict negative outcomes, and win broad support. Although broad public consultation is neither feasible for short-term lending nor absolutely critical if conditions are narrowly defined, the IMF should pursue opportunities, through its resident representatives, to establish more regular, informal contact between IMF officials, government officials, and the public in order to better assess the economic situation in member countries.

Carol Welch is an international policy analyst at Friends of the Earth in Washington, DC, where she specializes in international financial institutions.

Sources for More Information

Organizations

Bretton Woods Project
Box 100
London SE1 7RT
United Kingdom
Voice: (44-171) 523-2117
Fax: (44-171) 620-0719
Email: [email protected]
Website: http://www.brettonwoodsproject.org/

Contact: Angela Wood
Center of Concern
1225 Otis St. NE
Washington, DC 20017
Voice: (202) 635-2757
Fax: (202) 832-9494
Website: http://www.igc.org/coc/
Contact: Jo Marie Griesgraber

Centre for the Study of Global Governance
London School of Economics
Houghton St.
London WC2A 2AE
United Kingdom
Voice: (44-171) 955-7583
Fax: (44-171) 955-7591
Website: http://www.lse.ac.uk/Depts/global/

Focus on the Global South
c/o CUSRI, Wisit Prachuabmoh Building
Chulalongkorn University
Phyathai Rd.
Bangkok 10330
Thailand
Voice: (662) 218-7363
Fax: (662) 255-9976
Email: [email protected]
Website: http://www.focusweb.org/
Contact: Walden Bello

Friends of the Earth
1025 Vermont Ave. NW, Third Fl.
Washington, DC 20005
Voice: (877) 843-8687 (toll-free)
Fax: (202) 783-0444
Website: http://www.foe.org/
Contact: Carol Welch

Third World Network
228 Macalister Rd.
10400 Penang
Malaysia
Voice: (604) 226-6728, 226-6159
Fax: (604) 226-4505
Email: [email protected]
Website: http://www.twnside.org.sg/
Contact: Martin Khor

Publications

Jan Aart Scholte, The International Monetary Fund and Civil Society: An Underdeveloped Dialogue (The Hague, Netherlands: Institute of Social Studies, 1998).

Carol Welch, Arming NGOs with Knowledge: A Guide to the International Monetary Fund (Washington: Friends of the Earth, 1999).

Carol Welch and Angela Wood, "Policing the Policemen: The Case for an Independent Evaluation Mechanism for the IMF," available from Friends of the Earth or Bretton Woods Project.

Ngaire Woods, Governance in International Organizations: The Case for Reform in the Bretton Woods Institutions (New York: United Nations Conference on Trade and Development, 1997).

World Wide Web

Oxfam International
http://www.oxfaminternational.org/

European Network on Debt and Development
http://www.oneworld.org/eurodad/