Does global finance need a new Bretton Woods?

The Bretton Woods agreement – which is 70 years old this month – established three institutions to promote law and order in international economic relations:

• The IMF, to promote macroeconomic stability
• The GATT (and its successor, the WTO), to ensure an open trading environment
• The World Bank, to provide development finance for poverty reduction

The smooth operation of this rules-based, US-led global economic architecture contributed to the unprecedented economic growth and worldwide prosperity of the post-WWII period.

In more recent times, however, this architecture has lost much of its legitimacy because the world trade and GDP shares of emerging markets – especially those in Asia – have risen more rapidly than their shares in IMF quotas. For example, China accounts for 13.6% of the global economy (in terms of purchasing power parity), but its voting power is 3.8% less than that of the Benelux countries.

It is not that the IMF and the White House have not made the effort. In November 2010, the IMF management proposed what it labelled as the “most fundamental governance overhaul in the Fund’s 65-year history” (IMF 2010). If approved, the proposal would have reduced some of the quota misalignment at the IMF, fulfilled the G20 pledge to transfer 6% of the quota to dynamic emerging markets, and given China the third-largest voice in the IMF (Virmani and Patra 2011, Virmani 2012). The target was to make the reform effective in 2011, but – despite the strong support of Barack Obama – the proposal is still stuck in the US Congress. The cost of this delay is rising.

An important consequence of the slow progress in reforming the governance of the IMF has been the move from a centralized to a decentralized global economic architecture, in which regional institutions are being established to deliver international public goods in parallel with senior global institutions.

Other factors accounting for the decentralization are the need for a multi-pronged approach to manage financial globalization and the evolution of a multi-polar world (Rana 2013). For example, in the area of macroeconomic stability – where the IMF is regarded as the global financial safety net – we have the European Stability Mechanism, the Arab Monetary Fund, and the Chiang Mai Initiative Multilateralization as the regional safety nets.

Similar developments can also be witnessed in the international trade, financial and development architectures (Henning 2011). These trends complicate the governance of the global economy, and lead to duplication of efforts and wastage of scarce resources.

The situation has been aggravated further by the evolution of the China-led architecture in Asia. The recent establishment of the New Development Bank by the BRICS (Brazil, Russia, India, China, and South Africa) (BRICS 2014) and the soon-to-be-established Asian Infrastructure Investment Fund – both financed mainly by China – are signs that the country wishes to play a greater role in the global economic arena befitting its position as the number two – and the soon to be number one – economy in the world.

Establishing institutions dedicated wholly to providing infrastructure loans and guarantees is innovative, as they were lacking in the global architecture. But China’s recent moves also reflect its frustration at being unable to obtain a greater voice at the IMF and the World Bank.

Other components of the emerging China-led regional architecture are the recently-established $100 billion Credit Reserve Arrangement or the mini IMF among the BRICS (BRICS 2014) to tide over members in financial difficulties, and the Chinese desire to steer infrastructure development in Asia (both maritime and land-based) through its New Silk Roads policies without Western influence (Rana 2014). Through the latter initiative, China is exporting a central feature of its development model to the rest of Asia and the world. China spent 8.5% of its GDP on infrastructure development during the period 1992–2011, with the developing country norm being just 2-4% of GDP (The Economist 2014). The Regional Comprehensive Economic Partnership in Asia locks out the US, while the US-led Trans-Pacific Partnership locks out China. Going forward, we can expect more such initiatives from China.

While the China-led regional architecture in Asia does not pose a real threat to the IMF, World Bank and Asian Development Bank, it locks out Western countries – just as Western countries have locked out China – and further complicates the governance of the global architecture.

The Asian Development Bank has projected that Asia requires $800 billion till 2020 for developing infrastructure, compared to the total lending by the Asian Development Bank of $15 billion a year – roughly half of which goes to infrastructure finance (Asian Development Bank 2014). With an authorised capital of $100 billion, when expanded from the present $50 billion, the New Development Bank could lend about $15 billion a year. There is, therefore, ample room for everyone. Also, the Credit Reserve Arrangement is not a fund that can be used to stem an impending financial crisis, but a network of bilateral swaps with an absence of clearly specified rules on when they could be triggered and utilised.

What should be done? The issue could be resolved if the IMF and World Bank could work together with China-led regional institutions in a complementary and seamless manner. The ‘troika’ model (IMF 2013) – in which bailout packages are designed, financed, and monitored jointly by the ECB, the European Commission, and the IMF – is a good example. But it is unlikely that such an approach will be possible in Asia, as it would require the IMF to work jointly with the Chiang Mai Initiative Multilateralization and the ASEAN+3 Research Office.

This is because Europe is special to the IMF and Asia is not. Europe, which occupies 10 out of the 24 chairs at the IMF Board, has the second-largest voice in the IMF. If so, 70 years on, we need a New Bretton Woods, led by a select group from the truly systemically important countries of the world.

Published in collaboration with Vox

Author: Pradumna B. Rana, Associate Professor at the S, Rajaratnam School of International Studies, Nanyang Technological University, Singapore

Image: A yuan banknote is displayed next to a U.S. dollar banknote (back) for the photographer at a money changer inside the Taoyuan International Airport. REUTERS/Nicky Loh