G-20 Summit and the International Financial Institutions: Q&A with Nancy Birdsall

January 15, 2010

G-20 heads of state gathering in Washington this upcoming weekend to seek solutions to the global financial crisis should consider ways to strengthen the IMF and the World Bank, the international financial institutions set up after World War II, to prevent a repeat of the Great Depression. CGD president Nancy Birdsall outlines why and proposes a "Grand Bargain."

Q: How will this meeting of the G-20 be different than previous meetings?

A: The financial crisis has leveled the international playing field in unexpected ways. Interdependence and the need for collective action to solve common problems are more clearly evident now than ever before. Brazil, China, India, and other large emerging market economies are coming to Washington not as poor countries seeking assistance but as key players in helping to keep the global economy afloat in the coming months.

Q: Why should the G-20 heads of state spend time discussing the role of the World Bank and the IMF?

A: Organizations such as the World Bank and the IMF bind the United States and other countries to shared norms and agreed rules of the game. In a hyper-connected world in which collective action is difficult, shared institutions are crucial. It’s a cause for real concern that the IMF was not the first port of call for some emerging market economies when they were first hit by the liquidity crisis. The hesitation reflects two problems. One, the IMF has about $250 billion available—not enough to cover the likely needs of its members in the face of this crisis. Two, many emerging market members prefer to avoid the IMF anyway—whether because of the stigma of “needing” the IMF or because, conscious of what happened to Asian borrowers during their financial crisis in the late 1990s, they are concerned about undue and untimely conditions the IMF might impose. In fact, in the last couple of weeks the IMF has responded with a new liquidity facility— but the underlying problems of limited resources and legitimacy remain.

Q: Why is the IMF short of resources? And isn’t the World Bank awash in capital, with little demand for its loans?

A: Over the past two decades, as many emerging markets enjoyed healthy growth, there seemed little need to increase the IMF’s financial clout to reflect the inherent risks of huge cross-border capital flows—despite the growing global imbalances (including between Chinese surpluses and U.S. deficits). The IMF’s $250 billion to lend globally in response to the current crisis is barely one-third of what the United States has set aside for its own bailout. And that’s not even counting the U.S. outlays to rescue AIG and Fannie Mae and Freddie Mac

The World Bank, meanwhile, has seen a drop in demand for its traditional non-concessional loans, those available to middle-income emerging markets. During the recent boom years, these countries enjoyed high private inflows and sustained growth. In the late 1990s, World Bank lending to countries hit by the Asian financial briefly shot up, but that turned out to have been an aberration and those loans were not typical investment loans but more in the nature of IMF emergency gap-filling. Except for that brief period, the World Bank has gradually become less of a bank and more like one of many aid agencies serving only the poorest countries. But while the bank is flush with capital for traditional country loans, it has had to rely on a hodgepodge of special contributions to support global R&D on energy and agriculture, policy-relevant research, rigorous evaluation and innovations in development investments. The bank has the technical capability to make major contributions in these areas, but it lacks the funds. So there is a mismatch between its financing modalities and what the world needs it to do.

Q: And what about legitimacy?

A: The U.S. and Europe have continued to call the shots at both institutions. It’s not only that the United States names the head of the World Bank and that Europe names the head of the IMF; the old Atlantic alliance powers also have much more influence in board deliberations than the relative size of either their economies or their populations would warrant. This means that the big emerging market economies and the poorer developing countries have comparatively little input into deciding what the IMF and World Bank should do, and how they should do it. Without this input, the Bretton Woods sisters are seen as lacking legitimacy; and without legitimacy, they are at risk of losing their effectiveness as well as their relevance.

Q: So what’s the solution?

A: A Grand Bargain whereby the emerging market economies—and the rich oil economies of the Middle East—get more quotas in the IMF (that is, make a greater financial commitment and get more votes) and contribute to special funds to deal with global issues at the World Bank. In both institutions there would be an agreement on new contributions from the big emerging market economies in exchange for a greater say in how these intuitions are run.

Q: What would the money be used for?

A: In the case of the IMF, the money would be used to stabilize the global financial system and to support countries subjected to sudden shocks. While the conditionality of the IMF has sometimes been seen as misguided or intrusive, I think that everybody would agree that the impartial economic conditionality of the IMF is preferable to political conditionality that could accompany bilateral bailouts. In the case of the World Bank, new contributions would be directed to dealing with the global needs mentioned above, including the shared problems of climate change and lagging agricultural productivity. New contributions might also increase the resources for grants and concessional loans to the poorest countries; that would increase the bank’s readiness to provide countercyclical funding to the poorest countries hit by the ongoing crisis.

Q: Why should the emerging market economies want to prop up the multilateral financial institutions?

A: I think of it as an investment. These countries are struggling with very big and complex problems that no country can solve alone. The international financial institutions, for all their shortcomings, are the best mechanisms yet devised for organizing collective action to solve these problems, that is, to provide what economists call global public goods.There really is a mutual win here: these emerging markets take their rightful place as powerful economies, and the entangling dangers of direct country-to-country bailouts are mitigated by working through existing structures. It is the difference between China propping up Wall Street and the international community working together to solve the crisis.

Q: Do you think that this summit can make a difference?

A: This issue will not be the central concern at the summit—which will focus heavily on coordination of fiscal stimulus packages and on a shared agenda on financial regulations where harmonization across countries is needed—be that clearinghouses for derivatives, leverage limits, the role of rating agencies, or so on. Obviously it won’t be possible to reach a definitive agreement on these issues in a one-day summit, particularly given the U.S. political transition. However, I hope there will be at least a general consensus on the need to consider the future of the IMF and World Bank—including their roles, instruments, and governance. Both institutions currently have independent groups, led by Trevor Manuel in the case of the IMF and Ernesto Zedillo in the case of the World Bank, meant to address their futures. The Summit communiqué could allude to the importance of those efforts and the G-20’s interest in following up on the reports that they deliver.