NYU-A#6-MH Maura Hegarty October 29, 2000 International Organizations and Their Management – Prof. Kamal Three Recommendations for Reformatting the International Financial System Introduction: At the end of World War II it became apparent that a structured international financial system was necessary to rebuild the world economy.  Economic cooperation was not only necessary to help a financially devastated Europe, but also to ensure that the depression of the 1930s would not reoccur. The framework of the new world economy was based on the construction of regional and global institutions to revive international trade and deal with monetary matters.  These institutions helped facilitate the economic rebirth of Europe and parts of Asia and resulted in the increasing integration of the international economy.  While there is no doubt that these post-war reforms were positive, the international institutions established have often failed to achieve their goals and the economic benefits of the new economy have not been evenly distributed.  Therefore, almost sixty years later, it is necessary to reform the international financial system. Background of the International Financial System: John Maynard Keynes, an English economist, was a major architect of the post-war financial order.  Under his guidance the new international financial system was developed. It was designed to promote economic cooperation and stability and would rest on three pillars: the International Monetary Fund (IMF), the International Bank for Reconstruction and Development, also known as the World Bank, and the International Trade Organization (ITO).  (This final pillar was largely consumed by GATT and later the WTO.)  The IMF was responsible for “maintaining currency exchange stability and for helping member nations deal with short-term disequalibriums in their balance of payments” while the World Bank was accountable for “aiding in the reconstruction of war-devastated areas and in the modernization of underdeveloped economies.”   Recommendations for Reforming the International Financial System: #1. Reform the International Financial Institutions (the IMF and the World Bank): The roles of the IMF and the World Bank are extremely important to development in the Third World and also, to the success of the integrated new economy. For the policies of these institutions to be successful their infrastructure must be changed.  A major problem with both of these institutions is the lack of involvement by the developing world.  While their programs are largely directed at helping this segment of the international population, Western leaders or other developed nations primarily make the decisions.  Developing nations need to be included in the decision making process at all times, therefore they should be involved in the leadership of both the IMF and the World Bank.  An additional problem with both of these institutions is a lack of transparency.  Without transparency there can be no accountability, which is key ingredient to the success of these institutions. Transparency, “not only helps ensure better-informed citizens and investors, but also provides encouragement to policymakers to strengthen their policies and institutions.”   #2. Promote Sustainable Development: Sustainable development can not be achieved through economic policies alone. The official aid system was “based on the premise that transferring large amounts of foreign exchange to low-income countries was key to their development.”   There are numerous problems with this.  In countries with undemocratic regimes, or a lack of transparency in government, large inflows of aid can lead to corruption. In addition, this aid allows “countries to buy more things from abroad, thereby increasing their dependency rather than building self-reliance.”   Inflows of aid will not result in sustainable development; it will continue reliance on international financial institutions. To achieve economic development, countries must be able to utilize their abundant factors (land, labor or capital) and develop an economic base that allows them to compete in the global economy. Social development includes the formation of an accountable government and education and healthcare measures. While a strong social foundation will help a country in times of trouble, many economic policies have political risks. Therefore, international institutions should be ready and willing to support countries at these times through aid and continued development programs. #3. Implement Capital Controls: Capital controls were a major aspect of the Bretton Woods financial system and played a role in the strengthening of the global economy after World War II. Capital controls were particularly important because it allowed countries to have an independent monetary policy, thereby enabling states to deal with domestic economic problems. After the Bretton Woods system fell apart in the early 1970s, many states returned to a system with floating exchange rates and no capital controls.  The increased flow of capital has led to the integration of the world economy and has benefited many states.  However, this presents a problem for certain countries, not only because of the loss of an independent monetary policy, but also because increased capital flow leaves certain countries susceptible to speculative attacks.  Chile was able to implement capital controls on the inflow of short-term capital, while still encouraging long-term investment, thereby decreasing the likelihood of speculation.  This was done by taxing short-term capital by requiring investors to deposit, at zero interest, a proportion of their funds in the Chilean Central Bank.   Stopping speculation is not only important to emerging markets in Latin America and Asia, who have all experienced such attacks, but also to the developed world.  With the integration of the economy, speculative attacks on one nation’s currency can have devastating effects on the global economy.  Conclusion: For economic stability and prosperity to be realized by the international community, first, the international financial institutions must be reformed.  Without accountability and transparency, the IMF and the World Bank will lack legitimacy, and therefore will not be successful.  Secondly, no matter how much money is poured into a country, sustainable development will not be achieved without social development. This is necessary for governments to effectively deal with economic and political problems and to enable a state to become self-sufficient. Finally, the international community must realize that certain economic policies are not beneficial to all countries.  While free trade and unrestricted capital flows may be beneficial to the economy as a whole, they may not be beneficial to developing countries.  Therefore, international financial institutions must work with countries individually and determine what is the right policy for that particular country at that time. Once the country has reached economic and social development, restrictions and preferential treatment can be removed.  It is only through a concerted effort by the developing world and the international financial institutions that sustainable economic and social development can be achieved. These reforms will allow the developing world to enjoy the benefits of the new global economy and enable the international financial institutions to achieve their mandate.