The central focus of the code of conduct of the IMF has always been on the external sector of members' economies. And although, from a jurisdictional standpoint, the institutional mandate stressed the areas of exchange and current payments, the aim of a liberal trade system was at the core of the spirit of the code of conduct.47 In its operations with members, the IMF was also interested in attaining other related aims and in resolving balance of payments problems.48
Since Bretton Woods, the emphasis given to what may generally be called microeconomic issues (those having to do with efficiency in resource use), relative to that given to macroeconomic issues (those dealing with the balance between the aggregate demand for and availability of resources), has tended to increase. Perhaps to an important extent, the shift has reflected the fact that economic imbalances tend to increase in complexity in settings where discretion is the norm rather than the exception. This section will focus on three of the most conspicuous areas of concern.
In a system where members adopt the exchange arrangement of their choice, subject to constraints aimed at protecting the interests of the membership at large, the concept of an appropriate balance of payments position is not easy to define operationally. The relevant notion is sustainability or viability of the external payments position, which implies a time framework, and not a particularly short one at that. If external imbalance means that the balance of payments has reached a clearly unsustainable position, then the focus of policy must be on restoring viability to the balance of payments over the medium term. This concept includes objectives such as a sound growth rate and relatively stable price performance. Thus, although the balance of payments may remain the primary objective of surveillance and conditionality, the attainment of growth and price stability becomes an integral part of IMF functions. From this vantage point, it may be argued that trade-offs often perceived between balance of payments and price or output outcomes are more apparent than real and that the actual choice is instead between problems today versus problems tomorrow.49
This is the background for the development of the extended Fund facility (EFF) and of the enlarged time horizon for IMF stand-by arrangements. The concern was that balance of payments results achieved at the expense of domestic imbalances (such as sustained periods of growth below potential) would prove to be as short-lived as the attainment of domestic objectives (such as price stability or above potential growth) at the expense of balance of payments deficits. This meant an expansion of the policy understandings between the IMF and its members. It also meant an increasingly close relationship with the World Bank, which in a similar vein initiated its structural adjustment lending program, involving the extension of policy-based loans.50
The Bretton Woods order and the amended version of the Articles of Agreement currently in effect focused on attaining freedom of transactions at the current account level. The period that followed the abandonment of the par value system witnessed an unprecedented increase in international capital flows, particularly in the form of contractual lending. These growing transactions were instrumental in safeguarding interdependence in the international economy and as such were perceived as an indication of the resilience of the international financial system. But they also exhibited characteristics that caused problems to develop at a later stage. These were the predominance of contractual lending to sovereign borrowers and the resulting change in the structure or composition of capital flows. Capital movements rose markedly in scale but not uniformly across the full range of the various possible types of flows. Their main channels were commercial bank loans.
It is now a matter of historical record how these capital account developments led to a severe international debt crisis that seriously strained the fabric of the international financial system. Although the debt strategy that was adopted in response proved remarkably successful in achieving its central aim of eliminating the systemic threat, individual country debt problems are still outstanding.51 The international economy still confronts the fundamental challenge of setting the conditions for restoring normality to capital flows. And normality consists not only of the resumption of those flows on an appropriate scale but also of restoring balance to the structure of capital movements. That restoration should enable private foreign direct investment and equity flows to become important channels for resource transfers. Such a development, important at all times, can be critical at present to help along the reforms under way in previously centrally planned economies.
Of interest in this context is the complete liberalization of capital flows in several countries participating in the European Monetary System (EMS). This is an essential step that takes the EMS well ahead of Bretton Woods, the regime with which it is often compared. The liberalization of capital movements will pose an important challenge to the resilience of the EMS as well as test the arguments frequently made that viability of the system is contingent on the existence of capital controls.52 As a general matter, the steps taken within the EMS to provide freedom to capital movements are very much in accord with the aim of European integration as well as with the growing globalization of international financial markets. As such, however, they raise a question about the continuing appropriateness of the distinction in the Articles of Agreement between current and capital transactions, a distinction conceptually and operationally awkward.
One of the most, if not the most, stimulating of challenges facing the international economy in more than four decades is provided by the events under way in Central and Eastern Europe as well as in the former Soviet states. This is not only because of the opportunity to help these regions in their efforts to raise market economies from the ashes of central planning, but also because of the unique occasion to integrate the reforming economies within the international system and thus establish an economic order of a truly universal character.
Nowhere is the challenge more appealing than from the standpoint of the IMF. The role this institution has begun to play immediately with regard to the reforming member countries encompasses all its fundamental functions. It has started with technical assistance, a relatively less central function from the perspective of the code of conduct but, nevertheless, crucially important from the vantage point of reform. As there is an enormous need in these countries for technical assistance in many areas, the IMF is already providing its own expertise directly as well as in combination with official expertise drawn from member governments on many fronts. 53
The opportunity to establish a universal economic order challenges the IMF to focus on the broad area of surveillance. This general function can and should play the main role in the IMF's assistance to the reform effort. The rationale for this is that surveillance and reform share common aims: the purpose of reforms is to set the conditions for the establishment of free market economies, and the purpose of surveillance is to foster norms of behavior based on freedom of international transactions among member economies as a means of enhancing their common welfare. The new direction taken by these previously centrally planned economies sets them squarely within the membership, which is based on nationally chosen boundaries between public and private sectors rather than on the virtual dominance of government over the economy.
There are two dimensions of surveillance which acquire particular importance for the reforming economies. The immediate one is the policy advice involved in the exercise of surveillance that can assist them in laying the groundwork for the establishment of a market, an aim that may require surveillance to extend beyond its typical policy domains. The other dimension is the value of the demonstration effect that is generated by observance of the code of conduct by other members. Their example encourages reforming economies also to keep their markets open and abide by market discipline. Surveillance, by bringing the code of conduct to reforming economies, will assist them directly in their aim of setting up a market; and this assistance will be all the more effective if accompanied by the support of other members in the form of "preaching by example."54
The other major way by which the IMF can foster economic reform is, of course, through the exercise of conditionality. It is likely that most of the reforming countries will experience balance of payments needs requiring foreign exchange in amounts that exceed those they can earn or secure. Much more important is that they are also certain to experience urgency in making policy decisions that are likely to be required on a widespread front.55 It is in this sphere that the key input from conditionality should come.
Emphasis on the traditional policy areas of IMF conditionality-- appropriate macroeconomic management and rational pricing--is of course necessary for the process of reform to succeed. Less clear, though, is the sufficiency of the emphasis. This question of sufficiency arises from the absence not only of a market but also of a market-oriented institutional framework in the reforming economies. The bulk of general economic policy analysis presupposes the existence of a market and of market-supporting institutions. This is also the background against which conditionality has been developed and has typically operated. To ensure sufficiency, it may be necessary now more than it was in the past for IMF conditionality to broaden its scope in order to encompass microeconomic and institutional aspects of reform. This evolution will require developing adequate monitoring techniques in these new policy areas to ensure the effectiveness of conditionality. An additional requirement will be the establishment of linkages with, and support from, other institutions, such as the World Bank, the OECD, and the recently established European Bank for Reconstruction and Development (EBRD).56
Because of the need to break new ground in exercising surveillance and conditionality, certain avenues may be worth exploring. One course to consider would be linking not only the amounts but also the terms of foreign financial assistance to the exercise of conditionality in a broad spectrum of policy areas, including those required for the establishment of a market. This would mean that foreign financial assistance on an adequate scale and on concessional terms could be made available to support determined and wide-sweeping actions to dismantle central planning and help replace it with market-supporting institutions. The bulk of the assistance would come from official bilateral sources and from multilateral development institutions, which have the appropriate resources for financing the reform process.
The essential contribution of the IMF would be the policy content derived from its code of conduct in the exercise of both surveillance and conditionality; thus, Article IV and, if appropriate, other special consultations would be associated with foreign assistance. Use of IMF resources would also be involved, of course, but within the institutional constraints. In this regard, now may well be the right time for the IMF to steer away from playing a role of financial intermediary--as it has, increasingly, since the abandonment of the Bretton Woods order--and move back toward its original role of a cooperative lender; that is, the IMF, as an institution focused on a code of conduct, would stand ready to provide financial support on favorable (below market) terms as an incentive to countries in balance of payments need to continue their observance of the code. The institution would be able to provide financing on such terms because of the willingness of the membership at large to accept a less favorable (below market) return on IMF assets in exchange for the assured prevalence of the rules of the game.57
Apart from the development of monitoring techniques for measuring the reform process, an open question remains regarding the firmness of the linkage between disbursement of assistance and policy action. Financial support should be primarily for undertaking actual reforms, with lesser focus on terms of repayment--an approach that could help prevent potential conflicts between economic and political objectives. Utmost care must be exercised to ensure that the assistance is forthcoming only when policies are being implemented; otherwise, the risk of moral hazard will arise. However, there is no foolproof mechanism to ensure a flawless link between financial assistance and reform. It may be possible for the IMF to proceed a long way toward strengthening the link by adopting a firm attitude that agreed actions be in place prior to disbursements. It could also determine interruptions in those disbursements when there is evidence of deviations from policy understandings. A relatively solid link could go far in encouraging the implementation of necessary policy actions. Even so, risks will inevitably remain in an endeavor as complex as that in which the reforming economies are engaged.
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