Bretton Woods Institutions and their Effectiveness
Introduction
War times had brought several changes to the economies of nations worldwide; thus, the end of the First World War drove most countries to acquire their usual economic and financial stability. This then initiated the return to the gold standard, allowing leading economies to have their systems re-established. In this system, each country’s circulating money had to be supported by foreign currencies and gold reserves to a certain degree. However, the gold standard system caused the collapse of financial and economic relation, resulting to the Great Depression during the late 1920s. In order to overcome this economic downturn, every nation attempted to enhance the competitiveness of their products for export; this intended to reduce the countries’ payment balance through currency deflation. The strategy however, appeared to be effective only when the country’s rate of deflation is faster and stronger than the rest.
As a result, competition for international deflation heightened, causing major bankruptcy to various enterprises, massive unemployment, hyper-inflations and credit institutions failure. Though there had been conferences done in 1930s to resolve the world’s monetary concerns brought about by the Great Depression, all of these only led to failure. When the Second World War ended, the nations realized the dire need to develop a stabilizing system. Specifically, this innovative monetary system should supervise and monitor worldwide financial actions. This then resulted to conference at Bretton Woods at New Hampshire in the United States. The result of the conference is the creation of two major global agencies now known as the Bretton Woods institutions. In this discussion, focus will be on the description of these institutions, their objectives and responsibilities. In addition, the efficacy of these institutions in terms of achieving its objectives will also be analyzed. The major flaws and required changes to the institutions will be identified as well.
The Bretton Woods System
The conference in Bretton Woods took place in 1944, which had been attended by 44 countries. The primary objective of this conference was to formulate reconstructions within international currency and finance relations. The plan to develop the Bretton Woods system was initiated by two major economists of that time: , a British economist and , an American minister of state at the US treasury. As cited by these two economists, the development of the Bretton Woods system is a challenging task considering that the financial system must be one that will be accepted by all member countries (, 1980).
The delegation of the Bretton Woods plan led to the provision of a dominating power in the United States. Compared to other nations and despite the WWII, the United States had the economy with the most potential. Aside from being backed by gold, the US dollar at that time was the currency with the strongest purchasing power. The Second World War placed all European countries in great debts and had most of their gold transferred to the US; hence, the supremacy of the United States was undoubted. This then became the basis of the Bretton Woods system to select the US dollar as its key currency, which had been agreed by the participating nations.
The system is operated by two major institutions: The International Monetary Fund (IMF) and the World Bank. These had also been established in Washington DC in the United States. The system operated by implementing fixed exchange rates using the US dollar as the main currency. The actual system that defined its operations was patterned after the plans of and not . With this along with the other factors, the dominance of the United States over the Bretton Woods system was evident.
The Bretton Woods Institutions
It was on March 1, 1947 when the IMF started its first financial operations. Made up of more than a hundred nations worldwide, the function of the IMF is centered on the promotion of international monetary cooperation through the development of an international global monitoring agency, which will be in charge of supervising, consulting and collaborating monetary concerns and issues. Its main objective is to support world trade expansion so as to promote and maintain real income and high employment rates. It is also the objective of the IMF to ensure the stability of the exchange rate, thus, preventing competitive exchange depreciation. Its role is also concentrated on the elimination of foreign exchange restrictions and creation of payment system for multilateral trade. Most importantly, countries experiencing financial difficulties are given opportunities to correct them through the IMF and its available financial resources.
The chain of command observed within the IMF is operated by the administrations of the institutions’ member countries. The Board of Governors serves as the highest authority in the IMF, which is made up of a governor from each participating country. An equal number of representative governors called the Alternates also make up the board. The annual meetings serve as the main gathering for the members of the board. Daily activities of the institution are led by the Executive Board that is made up of 24 executive directors. The main function of this group is to supervise the implementation of the institution’s policies. Participating nations that have the highest quotas sends in one executive director to the board. The 23 other directors will be appointed through election.
In order for the IMF to work, each participating nation must provide a certain amount of money known as quota subscription; this is similar to a credit deposits in typical banks. Quotas then serve as the main financial resource of the IMF, which is used for granting loans to countries in need of financial assistance. The participating country encounter payment issues, 25% or more of its submitted quota which can be withdrawn immediately. Naturally, the quota contribution level of the member country is directly related to the amount of money that it can loan from IMF. Quotas also dictate the voting power of each member state. In exchange of having the loans, borrowing countries are expected to have their debts paid as soon as possible, usually within three to five years. In addition, it is imperative that the country show how its payment problems will be resolved.
The World Bank is the other institution operating within the Bretton Woods system. This institution is actually an independent agency of the United Nations. In order to be part of the World Bank, a country must also be part of the IMF. The Council of Governors serves as the highest authority of the World Bank and is made up of a single representative from each participating country. A total of five directors work for the institution’s Executive Board; this is the sector where most management of issues is transferred by the Council of Governors. The President of the institution is effectively elected by the US administration and verified by the executive board. This position is mainly in charge of the current activities.
The establishment of the World Bank is an important aspect of the global financial system, particularly among developing countries. As an essential source of financial assistance, developing nations are able to get a hold of loans that actually total to about billion every year. Through its well-trained workforce, financial resource and far-reaching knowledge base, the World Bank is able to assist every developing country towards a sustainable, equitable and stable path that will overcome the problem on poverty (, 2006). The main objectives of the institution include the improvement of the developing countries’ standards of living as well as the elimination of the most severe forms of poverty. Basically, it aims to facilitate the economic reconstruction process of the developing nations and provide sufficient capital to support it.
The promotion of foreign direct investment through partnership guarantees and acceptance with investors is also part of the World Bank’s objectives. Also, the aim of the institution is to ensure balance payments among the developing nations and support international trade. The World Bank has been established to formulate financial assistance strategies through coordinating with private institutions, non-governmental departments and government agencies. The institution has also been determined to achieve the goals indicated in the Millennium Development Goals (MDGs) since 2000. Specifically, these goals include the eradication of hunger and poverty, achievement of universal primary education. Promotion of gender equality and women empowerment, reduction of child mortality, improvement of maternal health, reduction of malaria, AIDS and other cases of harmful diseases, maintenance of environmental stability and development of global partnership towards progress (, 2006). In general, its main purpose is to provide financial, advisory, analytical and capacity-building services to nations with developing economies.
Effectiveness in relation to its Objectives
From the descriptions given, it is clear that the main objective of the Bretton Wood institutions is to support the economic development of nations worldwide as well as to enable economic opportunities for developing nations. These objectives are mainly achieved through the provision of loans that are accessible to all participating nations. Years of operations of the Bretton Woods system showed that these objectives had been achieved. One of the evidences was that the level of exchange rate stability moved favorably with the volatility level in both preceding and following periods. In addition, the Bretton Woods years also paved the way for extraordinary international trade and investment expansion (, 2000).
It has also been noted that the development of the macroeconomic performance during the Bretton years had been significant. In particular, the inflation rate was less than the average for every industrialized nation in exception of Japan as compared to the floating exchange rate periods that followed. Through the efforts of these institutions, the aim of improving real income was achieved as the growth o real per capita income during that time had been higher than any monetary regime; moreover, interest rates, with the aid of the Bretton Woods institutions had remained stable and low (, 2000).
Aside from these actual effects, the objectives of both institutions had been achieved through their continuous development and implementation of helpful financial programs, especially for developing nations. For instance, the World Bank has a sub-agency called Multilateral Investment Guarantee Agency (MIGA) which mainly provides risk-balancing insurance services to support the foreign direct investment projects of the developing nations. Political risk insurance is typically provided by the sub-agency so as to protect investors from administrative expropriations, terrorism, conflicts and other similar factors. This in turn enables investors and lenders to pursue investment projects without the disruption of external risks. Through MIGA, developing nations are also able to attract and maintain private investments, allowing developmental sustainability.
Through this agency program, potential investment risks are reduced significantly through insurance. This increases the chances of investment success that developing nations need. The activities of MIGA also result to yet another important outcome, and that is it encourages developing nations to adapt financial policies which will promote investment. In other words, aside from providing insurances, financial reforms at the local level are also developed through MIGA’s efforts. This effect had been made evident through actual projects of the sub-agency.
One project was conducted in Azerbaijan where insurance had been provided for the Turkish investors so as to modernize and expand a flourmill, which will be used to produce and distribute flour in Azerbaijan and Georgia. Another example was the Ecuadorian project where investors had been supported by MIGA for the construction of a new airport. This will serve the Quito capital, which in turn, will expand and improve economic trade and development in the region (, 2006). Aside from this, the Bretton Woods institutions were able to achieve their objectives effectively by coordinating with the HPIC or the Heavily Indebted Poor Countries which aims to provide debt relief, particularly among developing countries.
Although there had been a number of evidences that emphasize the efficacy of the institutions in achieving their set financial objective for nations worldwide, there had still been issues suggesting that the operations of both IMF and World Bank have not been as efficient. Even without the conduction of ample research, this claim can be made evident by the obvious state of most developing nations – many are still under considerable debt, diseases still affect these nations, several regions of these countries remain affected by hunger or malnourishment and economic statuses remain unstable. Within the most indebted nations, debt remains the main cause of poverty in spite of debt relief efforts. According to (2000), there are about 40 countries who are still suffering from extreme poverty, making them very vulnerable to external risks and unexpected crisis. Their economic state is further worsened by internal conflicts and epidemics.
In order to respond to these problems, the Bretton Woods institutions and the richest bilateral donors planned to aid highly indebted poor countries by reducing their external debts to a sustainable level. This plan was initiated mainly due to the pressure of the non-governmental organizations, church groups and Jubilee 2000 movements. Though the plan was considered a breakthrough, its expected significant progress is still not achieved. Specifically, there were only nine nations that were able to receive debt relief in 2000 out of the scheduled twenty-five countries (, 2000).
It appears that this problem is attributed to the institutions’ inadequate political will. Although the Clinton government had then given its strong support for the provision of debt relief, the American Congress had not given the money for its share. In 1999, a legislation was passed by the Congress to authorize the full cancellation of the bilateral debt for the HIPCs, which was around 5 million. In 2000, 5 million was agreed upon for allocation while the Congress has not authorized and appropriated the funds for multilateral debt relief (, 2000).
As suggested in the discussion regarding the development of the Bretton Woods institutions, it is very obvious that the United States dominates the system. Having the most stabilized economy and the key currency; the global institutions appear to be influenced by a single nation. Considering that the US has so much power over the donor community, the failure of the Congress to provide the fund for the HIPC effort can be a good excuse for other nations to hold their contributions as well. This then becomes the main reason for the delay of the debt relief and the continuous poverty among developing nations. Aside from the lack of political will, the inefficacy of the Bretton Woods institutions to achieve their objectives is also caused by the institutions’ apparent weaknesses.
One of these weaknesses is it includes the restriction of the governments for international capital movements; these restrictions then limited the international flow of capital. The Bretton Woods system also works through adjustable exchange rates. Such system is difficult to implement as the rate of adjustment is difficult to predict; moreover, this system cause pressure and for others to speculate, resulting to forced adjustments. This becomes a problem especially because the US and European countries are not willing to adjust their exchange rates. Once the exchanges had been adjusted eventually, mounting speculations and major financial crises often ensue. Another weakness of the system was that it was only the United States that is required to have its domestic currency converted into gold. This ruling was not effective as the United feared that the world’s confidence for the US dollar will reduce as its gold reserves deteriorate (, 2000).
According to (1985), the inability of the Bretton Woods institutions to achieve its objectives, especially among developing nations, is brought about by a number of external reasons. Specifically, the funds to be provided for less developed countries become less as US and other wealthy nations focus on other investments. The objectives are not met as poor nations cannot provide the minimal contribution necessary for their investment. In other cases, the effective goal achievement of IMF and the World Bank is hindered by governments aiming to climb and stay out of debt by reducing their level of participation and contribution to the system.
From these given conditions, it can be said that while IMF and the World Bank have effectively achieved their set objectives through programs, financial resources and efficient staff, there are still factors that hinder their full accomplishment. In general, the factors that affect the objectives of the Bretton Woods institutions can be categorized as both internal and external. Internally, the institutions clearly lack an established authoritative and political standpoint. Apparently, the flow of the system appears to be significantly affected by the decisions and plans of the United States and other major contributors. Without a good internal government for both institutions, the overall operations of the system will only be influenced by a few members; this in turn will only increase speculations and conflicts. It is then necessary for the institutions to reconsider its goals and means of achieving them. Most importantly, there should be a redefinition of how the system should really work rather than basing its operations on quota contributions and economic stability.
The external factor that affects the institutions is mainly characterized by the individual governments of the participating members. Having no control over national policies, it is then difficult for IMF and the World Bank to regulate the individual financial and economic plans of the nations in such a way that their objectives will not be affected. However, both institutions have the power to develop and implement new means for a more effective financial system. For this matter, it is imperative that both institutions should reconsider its objective and adjust policies to promote their achievement.
Conclusion
The development of the Bretton Woods system led to the formation of two major financial institutions, namely the IMF and the World Bank. As global institutions, these are responsible for supporting the economic growth and stability of participating nations through loans and funds. While there had been evidences of progress brought about by the institutions’ efforts, certain factors appear to hinder the full achievement of their developed objectives. For this reason, it is then necessary for these institutions to develop an established political sector that will enhance both its management and policy development sectors.
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