The International Monetary Fund (IMF) and the World Bank
concluded their annual meetings on October 22. Both institutions
have new leadership and face serious questions about their role in
an increasingly globalized world awash in private capital. The IMF
today is an institution without a clear role. Its original mission
ended with the expiration of the Bretton Woods system of fixed
exchange rates in the early 1970s, and it has assumed several
missions since, most recently the role of bailing out developing
countries facing financial crises. The growth of global markets,
however, makes this role increasingly untenable, and the moral
hazard created by the implicit guarantee that the IMF will step in
when needed casts doubt on the wisdom of this role, in any case. It
is past time to fundamentally reevaluate the mission and structure
of the IMF to make it better fit the modern world. The IMF can fill
a useful role by providing sound economic and fiscal advice to
governments. This role does not require its current resources,
however, and new IMF managing director Dominique Strauss-Kahn
should propose transforming the IMF into a leaner institution and
returning the bulk of IMF resources to the member states.
The Increasing Irrelevance of the IMF
The IMF was created in the waning years of World War II as a key
part of a strategy to prevent a recurrence of the economic
recession and depression that preceded and contributed to World War
II. Under the rules established for the Bretton Woods system, each
currency was assigned a value in gold that was to be maintained
within a narrow range. The IMF was the mechanic that kept this
system running smoothly.
For the first quarter century of its existence, the IMF had a
clear mandate, but in the late 1960s and early 1970s, the system of
fixed exchange rates that the IMF was set up to oversee began to
break down. The United States loosened the dollar peg to gold in
1968 and discarded it completely in August 1971. This rendered
irrelevant the primary function of the IMF.
Instead of reducing its activities, the IMF sought out new
missions to justify its continued existence. As successive crises
erupted, the IMF reoriented its focus to deal with them. From the
oil crises of the 1970s to the 1997 Asian financial crisis, the IMF
moved from crisis to crisis to justify increased lending, arguing
that each situation would be much worse absent IMF intervention.
Throughout this process, the IMF doled out economic prescriptions
along with financial assistance to many developing countries.
Recipients often chaffed under the policy prescriptions of the IMF
and increasingly sought to avoid IMF assistance and the
accompanying restrictions. As noted by The
Just a decade ago, the fund, famous for its bailouts of troubled
developing countries, was at the center of tumultuous financial
events in Asia, Russia and Brazil. Those countries have recovered,
paid back their emergency borrowings and gone on to pile up
international reserves…. Asian resentment at the way
Western-led institutions handled the 1997-98 Asian financial crisis
has given rise to the Chiang Mai Initiative, a 13-nation accord to
pool resources for the next crunch. It has far more money available
than the IMF could muster.
Simultaneously, other countries began seeking out less
prescriptive sources of financing. Countries with access to
international capital markets are tapping them rather than going to
the IMF. In Latin America, finance ministries have expressed
interest in creating a "Bank of the South" which could supplant
many of the IMF's traditional functions in economic or balance-of-
payments crises. Countries like Angola borrowed from China rather
than bow to IMF demands for increased transparency that accompany
its financing. Today, the IMF finds itself a lender with
few customers. According to The Washington
Post, "The IMF has only $11 billion in credits
outstanding; it is sitting on $252 billion in usable resources."
What Role for the IMF?
On November 1, 2007, Dominique Strauss-Kahn, a former French
finance minister and presidential candidate, will begin his term as
the new managing director of the IMF. Mr. Strauss-Kahn should use
his term to reshape the struggling international financial
institution for the modern, rapidly changing global economic
system. In his interview with the IMF Board of Governors, Mr.
Strauss-Kahn vowed reform and acknowledged that "it will be a hard
task for all of us to rebuild both the relevance and legitimacy of
this organization. But I am prepared to do that and I ask you to be
prepared as well."
So what is Strauss-Kahn's vision for the "rebuilt" IMF? He
acknowledged the need for the IMF to carefully examine its size and
functions, reduce expenses, and develop a sound source of income.
However, he also said, "We don't need less IMF, we need more
IMF." More IMF is needed, he said, "for the IMF
to make financial stability serve the international community,
while fostering growth and employment." This plan ignores
The IMF has become a marginal player in managing the global
economy. Even if it could get nations to borrow, it is uncertain
what purpose the loans would serve. As more countries eschew
currency pegs and fixed exchange rates, there is less need for IMF
lending to maintain currency values. Indeed, absent rock-solid
fixed exchange rates under a currency board or similar arrangement,
efforts to mange or peg currency values simply invite currency
The days when an institution like the IMF can arrest serious
global financial crises are waning or ended. It simply doesn't have
enough money. Today's global markets facilitate the flow of
trillions of dollars in private capital. In 2006, international net
capital flows totaled more than $4 trillion, of which $650 billion
went to developing countries. Global trade of goods and
commercial services exceeded $14 trillion in 2006. The usable
resources of the IMF, at less than $300 billion, are minimal in
relation to international financial flows-certainly insufficient to
counter private capital flows. Solving serious financial crises
through IMF bailouts is simply no longer possible. Worse, attempts
or implicit promises to perform such a role arguably increase
market volatility and the likelihood of crisis by creating a moral
hazard that encourages imprudent risk-taking by governments and
In its search for a mission, the IMF has become increasingly
involved in development. This blurs its mandate and treads on the
mission of the World Bank. Unfortunately, Strauss-Kahn seems
inclined to go further down this path based on his desire for the
IMF to be active in "fostering growth and employment." Though the
World Bank has seldom been successful in this mission, it does
possess far more expertise and experience in these areas than the
IMF. The IMF is unlikely to do a better job of achieving the Bank's
mission than the Bank.
The one resource that the IMF possesses that remains relevant is
its expertise and experience in providing governments with sound
economic and financial advice. International markets and private
capital flows react to policies: Prudent polices are rewarded with
investment and access to capital, and poor policies are punished as
investment flees and credit is frozen. Governments should use the
IMF as an impartial consultant and advisor on economic policy.
Specifically, the IMF should seek to advise governments on how to
transition toward greater economic freedom.
Enhancing economic freedom is crucial to economic development
and sustained prosperity in an increasingly integrated global
market. Economic growth and prosperity depend on maintaining and
improving an environment in which entrepreneurial activities and
innovation can flourish. Countries with higher degrees of openness
and flexibility benefit from the free exchange of commerce and
thereby enjoy sustainable economic growth and prosperity. This
relationship is documented in the Index of Economic
Freedom, published annually by The Heritage Foundation
and The Wall Street Journal, which measures economic
freedom around the globe. The empirical findings of the
Index confirm that countries with greater economic freedom
are more prosperous than are those with less economic freedom.
In other words, economies built on greater economic freedom are
inherently and fundamentally stronger.
Mr. Strauss-Kahn should pursue reforms to focus the IMF on
promoting economic freedom. While not as dramatic as organizing
bailouts or crisis management, this role would make a big
contribution to the IMF's historical mission of promoting stability
in international financial markets and its stated desire to promote
economic growth and development. A leaner, more focused IMF could
also return most of its current reserves to member states,
retaining only a small portion sufficient to fund expenses through
returns on investment.
To a great extent, Mr. Strauss-Kahn's success depends on how
seriously he implements real changes in close coordination with
reform-minded member states. Reformers should urge Mr. Strauss-Kahn
to overcome institutional inertia and transform the IMF into an
institution better suited to the modern world and able to provide
useful services to member governments. Specifically, Strauss-Kahn
should eschew the temptation to maintain the IMF's futile mission
to counter private financial markets and manage financial crises.
Nor should he attempt to infringe on the mission of the World Bank.
Instead, he should seek to make the IMF a leaner institution
focused on using its expertise and experience to provide sound
economic and financial advice to countries seeking to adjust to a
global economy that rewards entrepreneurship and economic
Schaefer is Jay Kingham Fellow in International Regulatory
Affairs in the Margaret Thatcher Center for Freedom, a division of
the Kathryn and Shelby Cullom Davis Institute for International
Studies, and Anthony B.
Kim is Policy Analyst in the Center for International Trade and
Economics at The Heritage Foundation.
system was named after Bretton Woods, New Hampshire, where
representatives from 44 nations negotiated the details of the new
international financial institutions. The dollar was fixed to gold
at $35 per ounce and backed by U.S. gold reserves, which led many
countries to hold dollars as a reserve currency in place of
"Crisis Comes to the IMF," The Washington Post.
Global Development Finance 2007: The Globalization of Corporate
Finance in Developing Countries (Washington, D.C.: World Bank,
2007), at http://go.worldbank.org/A6NOL5UPY0, and
International Monetary Fund, "Global Stability Report: Financial
Market Turbulence: Causes, Consequences, and Policies," September
2007, at www.imf.org/external/pubs/ft/gfsr/2007/02/index.htm.
In 2006, worldwide FDI inflows were about $1.2 trillion. Other
capital flows include portfolio equity investment, which is more
liquid and volatile.