Towards a New Global Economic Order
The International Monetary Fund and the World Bank have evolved over time but not to the extent that is warranted.
When the finance ministers and central bankers from all over the world gathered in October in Washington for the annual meetings of the International Monetary Fund and the World Bank Group, there were several issues on their minds concerning the global economy. They worried about the slow revival of the global economy after the Great Recession of 2007-09 and there ware considerable concerns about the failure of the WTO to save the institution from collapse because of the absence of an agreement in the latest round of trade facilitation. While the ministers did not formally discuss at the meetings the crises in the Middle East and the Russian moves against Ukraine, the economic impact of these moves were of concern for them.
Also on their minds was the creation of the two BRICS institutions, the New Development Bank (NDB) and the Contingent Reserve Arrangement ( CRA) and how that would affect the working and reach of those that are already in place. Most of the commentary that appeared after the creation of the two institutions was focused on the need to replace the Bretton Woods institutions with those that better reflected the current structure of the global economy.
The present structure of the global economy is very different from the time 70 years ago, when the victors of World War II gathered in a small resort in the American state of New Hampshire to design a new international political and economic order. The objective was to avoid the pitfalls of the one that was put in place after the end of the previous global conflagration, the First World War. Most historians agree that the focus on punishment and compensation was a mistake. Germany and its allies were to be punished by having them compensate for some of the costs incurred by those who had suffered at their hands. This, the “victors take all” approach, laid the ground for the Second World War.
A lesson had been learnt when the Second World War was about to conclude. This time around, the defeated nations were to be brought into a refashioned political, economic and financial system. The United Nations was to oversee the evolution of the international political system while three institutions were to deal with various aspects of the global economy. The International Monetary Fund would watch over global payments and step in with help if one of the member countries was unable to meet its foreign obligations. The International Bank for Reconstruction and Development, as its name implied, would help with the reconstruction of the economies seriously damaged by the war. It would also work to promote the development of the European colonies in Asia and Africa as they began to
There is no doubt that if the Fund and the Bank were to be created now – in 2014 – their structure would look very different. They have evolved over time but not to the extent that was warranted. The global economic system has profoundly changed since 1944. China is now the world’s second largest economy, on the way to becoming the largest. It has overtaken Japan and is likely to pass the United States in a year or two.
emerge from colonial domination. The World Trade Organization would regulate international trade and set up a dispute resolution mechanism to handle trade-related conflicts among member nations.
While the IMF and the IBRD (now called the World Bank Group) became operational immediately after the conferees at the Bretton Woods concluded their work, it took 50 more years before the WTO could be founded. The Bretton Woods conference also agreed on the mechanisms for funding and managing the institutions. It was easy to decide that the bulk of the capital for the two finance and development institutions would come from the United States, the only country among the victors that still had the economic and financial strength to shore up the global economy.
But other victors such as Britain, France, China and Russia also needed to be rewarded though their economies were left in tatters by the war. A simple formula was devised. Most of the finance would come from the United States while the five victor nations will have a voice in policymaking. This meant the grant of the veto power to the five in the United Nations, and significant voting power to Britain, China and France in the IMF and the World Bank. Russia, then called the Soviet Union, decided not to support the creation of the Fund and the Bank while the Chinese chair in these two institutions was occupied by Taiwan until 1981 when Beijing came in and Taipei went out.
There is no doubt that if the Fund and the Bank were to be created now – in 2014 – their structure would look very different. They have evolved over time but not to the extent that was warranted. The global economic system has profoundly changed since 1944. China is now the world’s second largest economy, on the way to becoming the largest. It has overtaken Japan and is likely to pass the United States in a year or two. The United States, China, Japan, Germany and France are the five largest world economies accounting for 37.2 percent of the total. If we rank countries by their share in world trade, the top five nations are China, the United States, Germany, Japan and France. Together, these five account for 59.6 percent of the share in the total world trade of $33.7 trillion. The Chinese and American shares are 12.4 and 11.1 percent, respectively.
Foreign exchange reserves could be another indicator of economic strength. The five largest reservesholding countries are China, Japan, Saudi Arabia, Switzerland and Russia. The continuous increase in the size of China’s foreign exchange reserves and how the country manages them are two issues that have been receiving a great deal of attention. The country’s reserves rose to just shy of $4 trillion in the first quarter of 2014, about one-half of the world total. Although the composition of the reserve is a tightly held secret in Beijing, the Bank of International Settlement has estimated that some 70 percent is held in the United States’ money market instruments. Investments in the United States are not only in treasury bonds. China is also heavily invested in the bonds of such U.S. agencies as the Fannie Mae and Freddie Mac. For the last several years, Beijing has been working on diversifying its foreign holdings. With that mind, it has created a sovereign fund of its own and is one reason why it pushed for the creation of the NDB.
India’s very large financial need for improving its infrastructure also played a role in creating the NDB. It is estimated that it needs one trillion dollars of investment in the next five years. Each of these considerations will be important in influencing the evolution of the NDB and the CRA. But the existing system also needs to be reformed. It is too large and too wellestablished to be by-passed by a new institutional set up. But tinkering at the margin will not help. If the structure of voting strength in the World Bank, for instance, was to reflect the weighted average of the size of the economy, the size of the population and shares in international trade and foreign reserves, the five largest countries will not be the United States, Japan, Germany, France and the United Kingdom but China, the United States, Japan, Germany and India.
Under the present dispensation the current five have a combined share of 35.8 percent with the U.S. at 15 percent, Japan at 8.1 percent, Germany at 4.6 percent and France and UK at 4.05 percent each. In the revised share-holding, UK and France would drop out to be replaced by China and India. The combined share of the new five could be set at onethird of the total. This arrangement could be revisited every year and the holding of shares revaluated. The writer is a former finance minister and served as vice-president at the World Bank.